Description

Long: VF Corporation (VFC) – Turnaround Underpinned by Great Brands

Thesis

Despite being a staple in the consumer retail space, VFC has never been written up on VIC. For more background on the evolution of the business from textile maker to brand platform see Legend of VF Corporation by Jeffrey L. Rodengen.

VF Corporation is a storied owner-operator of lifestyle brands that has lost its way. After 5+ years of focusing on portfolio transformation + sustainability (management-speak for overpaying on M&A and a lack of focus on the fundamentals), VF has been backed into a corner financially, which has required decisive action. With Steve Rendle out as CEO, and a re-focus on execution, ROIC and FCF, we believe VF is at an inflection point with material upside for the equity. 

Underpinned by great brands, VF backed themselves into a corner through a balance sheet levered at >4x and stagnation in once high-flying brands (Vans, Supreme, Timberland, Dickies all declined YoY). Steve Rendle made a big bet on eliminating low growth, high cash generating brands in an effort to reposition VF as a high-growth, vertically integrated DTC platform. While there were a few flaws in this strategy, it recently blew up when Vans growth hit a wall combined with the poorly timed acquisition of Supreme (Nov 2020) at peak sales / margins (bringing leverage to >4x).  

Despite these missteps, VF is still a good business that generates significant FCF in a normalized margin environment (operating margins declined from 13% to 10% YoY; normalized >14%). Our thesis is focused on steady-state FCF generation over a 3-5 year time horizon. Operating performance has bottomed out, and the core business is set to return to LSD% growth. Investors are myopically focused on broad consumer sentiment, reflected in wholesale performance, and with VF, in particular, the capital structure. In our view, the wholesale headwinds are fully priced into the stock and there is a glidepath to right-sizing the balance sheet. Upside from material FCF improvements, combined with opportunities for more aggressive capital structure improvements provide the opportunity for a win-win outcome for investors. In our base case, we believe VF can generate >$1B of FCF translating to a forward levered FCF yield of >9%. While FCF will almost exclusively go towards debt reduction, VF’s capital structure is hamstrung by ~$700M of annual dividend payments (6.5% yield as of 5/24/23). There is an opportunity to improve the balance sheet in the short term by a reduction/elimination of the dividend (management signaled a reduction this in their 5/23/24 earnings call) and an aggressive rationalization of the cost structure. VF is also an excellent activist candidate as most of the errors have been management missteps rather than secular headwinds in the market.

Ultimately, at an entry point of 15x levered FCF / <10x P/E (on management estimates of $900M FCF in 2024) we believe VF provides an opportunity to own a good business at a good price. Without any assumptions around multiple expansion, LSD% growth and normalized margins provide a base case of high teens IRRs, with limited risk of permanent capital impairment.

We see a path to $40 per share on our 2027 assumptions (Mar. year-end), corresponding to a >20% IRR on a 4-5 year view. Incremental upside can be driven by more aggressive capital allocation decisions to improve the reinvest profile of the business (i.e. reduction of the dividend and a cost reduction plan) and possible activist involvement.

Business Overview and Timeline

Source: Independent Research

VF owns some of the world’s most recognized brands: Vans, The North Face, Timberland, Supreme, Dickies and others. VF hit home runs was with its purchases of Vans and The North Face (“TNF”) out of distress in the early 2000s. Through the cash flow derived from the Jeanswear segment (Wrangler Jeans, Lee Jeans; spun off in 2019), VF was able to invest in building Vans and TNF into two of the dominant vertically integrated retail brands in the outdoor lifestyle segment. More recently, Steve Rendle became CEO in January 2017 (He was previously President of TNF and COO of VF) and embarked on an aggressive pivot from his predecessor’s strategy. Rather than focusing on disciplined management of existing brands, while slowly acquiring new brands over time, Rendle was enthralled with the success of companies like Amazon and Nike who were high growth, technology forward and DTC focused. In an effort to get VF re-rated into that camp, he put forward an expansive portfolio and digital transformation plan for VF. This began the fast pace of acquisitions and divestitures (see chart below), while also moving the company (and relocating most brands) to Denver, CO. The most transformative action was the spin-off of the Jeanswear segment into its own publicly traded company Kontoor Brands (NYSE: KTB). While the market originally fancied the strategy, growth in core brands, especially Vans, began to soften, while at the same time VF took on 4x leverage in the wake of the Supreme acquisition ($2.1B).

On the DTC front, Rendle’s strategy was largely successful. The sales mix is now largely 50/50 across DTC/wholesale (up from 25/65 in 2019). However, this shift introduced inherent complexity for an organization that had been predominantly wholesale focused. This was evidenced in the inventory fiasco of Fall 2022 (Q2 2022 earnings), which had a big role to play in Rendle’s ouster, putting aside the precipitous decline in the stock price (~80% decline from high of $90 at end of 2019 down to a low of $19 today). 

Ultimately, Rendle began to create a moving target of the strategy (revised the strategy twice after not hitting targets), which destroyed his credibility despite making some bold operational changes. It was necessary to remove him, and I believe more leadership changes will happen in the near future. 

Not surprisingly, the Jeanswear segment has flourished after it’s spin-off as it is now able to use its high FCF conversion into opportunities for reinvestment (see Ladera838’s 5/4/22 KTB post for more detail).

Source: VF Supreme Deal Announcement Deck (Nov 2020)

Top Four Brands

For an in-depth look at the brands / business see the 2022 Investor Day: [LINK]

Source: VF Q4 2023 Press Release (Filed 5/23/23)

1. Vans ~$3.6B / ~32% of sales: Vans is a California skateboarding brand turned into global action-lifestyle brand. Vans became increasingly trendy in the wake of streetwear excitement, social media “hype” brands and the underlying recognition that Vans paired well across fashion styles. It has been the core driver of top-line growth over the last five years. 

2. The North Face ~$3.6B / ~31% of sales: TNF is an outdoor lifestyle brand that is most famous for its black winter coat with the white logo. While it is primarily known for its winter gear, great effort has been made to turn TNF into a true four-season lifestyle brand. 

3. Timberland ~$1.8B / ~15% of sales: Timberland is outdoor lifestyle brand known primarily for its boots. Most importantly, the yellow boot which most consumers just call “Timbs.” Timberland was formerly an independent publicly traded company that was acquired in 2011. It’s lack of growth since acquisition has probably been one of the biggest disappointments for VF.

4. Dickies ~$0.8B / 6% of sales: Dickies is a Texas based workwear turned lifestyle brand. Known for their work pants, Dickies capitalized on streetwear trends and the Asian love of US workwear to elevate Dickies core consumer into a fashion forward hype brand. This was Steve Rendle’s first acquisition at the helm of VF.

Source: VF September 2022 Investor Day

Key Operating Risks

1. Vans sales drop-off accelerates.

   1. Vans slump surprised investors and management. Has the brand lost its “cool” factor for consumers?

   2. Vans product line exploded; will management re-focus on the core consumer?

   3. What operational sins have been covered by Vans sales growth the last 10 years? 

2. Normalized operating margins lower than expectations.

   1. Brand mix shift + price inflation should lead to higher normalized operating margins. This is what management has communicated as well. However, with sales declining, VF could suffer from operating leverage headwinds

3. Lack of reinvestment from the constrained balance sheet leading to further brand deterioration

4. Capital Structure Stubbornness

   1. Management have signaled a willingness to reduce the dividend. Are they willing to take aggressive measures to clean up the balance sheet in the near term?

5. Continued sales declines could lead to forced asset sales, which would compromise the health of the platform

Appendix 1: VF Brand Portfolio

Appendix 2: Vans Sales Growth (2004-2022)

Appendix 3: TNF Sales Growth (2000-2022)

Catalyst

• Cut Dividend
• Return to normalized operating margins of ~14%
• Aggressive Cost Reductions
• Upside: Activist Involvement