Diversified Retail Stock with Upside Potential
Ashish is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Under a tough macroeconomic backdrop many retail companies have taken a beating; recent examples include Aeropostale (NYSE: ARO) and Abercrombie and Fitch (NYSE: ANF), which saw a downfall of ~33% and ~15% respectively following their quarterly earning call. However, V.F. Corporation (NYSE: VFC) which is better known by the names of its 35 brands reported good results, upgraded guidance and demonstrated that it can find growth drivers within a diverse portfolio of brands. We believe the company has many growth drivers for the next several years, including continued growth in Outdoor & Action Sports brands, growth in international markets (especially Asia), and global expansion of Direct to Consumer in key lifestyle brands and newly acquired brands in the contemporary coalition.
Profit Margin Improvement Likely to Continue
Outdoor and Action Sports is the highest growth segment (45% YOY revenue growth in Q2) for the company and VFC’s margins continue to benefit from mix shifts to higher margin channels and geographies. The company posted a 160 basis point expansion in operating margin in Outdoor and Action Sports (excluding Timberland). Apart from that, the Jeanswear operating margin in Q2 was better than expected (up +30 bps to 15.7%) due to lower manufacturing costs in company-owned plants and tight inventory controls, which helped to drive overall gross margin higher than expected. Though Jeanswear sales were down 3%, we think they should normalize in 2H12 as it was merely a consequence of a shift of spring seasonal products into 1Q12. Profitability is expected to continue to improve in 2H12 as product costs come down further. Furthermore, the increase in DTC as a percentage of sales (new store openings and e-commerce sites launches in new markets) is another potential driver for VFC’s longer-term margin expansion.
Robust International Growth
Despite investor concerns, VFC demonstrated its ability to show robust growth internationally with its diversified brands. VFC remains immune to recession in Europe and slowdown in China. In 1H12, company’s revenue in constant dollars increased 14% in Europe and 19% in Asia. The management reiterated FY12 guidance at low double-digit growth for Europe and 20%+ growth for Asia, which signifies management’s confidence in the brand’s positioning in the region. The company has targeted to achieve 40% of revenues from international markets by 2015. The company’s investments in its brands (retail and e-commerce roll-outs) appear to be gaining traction in a difficult market. We also consider VFC’s brands underpenetrated relative to established players like Nike (NYSE: NKE), creating attractive runway for international growth. VF's movement into China is still in the beginning stages, so there is plenty of future growth opportunity in that region.
Inventory Growth in check
Though, the inventory growth of 22.1% was above sales growth of 16.4%, excluding Timberland, inventory was up just 3% vs. organic revenue growth of 6%. As a result, forward day’s inventories were 82, compared with 118 at the end of last quarter. Going into Q3, as VFC nears the peak demand period there can be an upside to the inventory levels. Nonetheless, we remain impressed by the company’s conservative approach to inventory management in this uncertain macro environment.
Despite industry headwinds, VF appears to be well positioned to outperform its peers, given strong organic growth from The North Face and Vans, continued outgrowth of international and direct-to-consumer businesses and operating margin improvement. The company is trading at a forward P/E of 13.36, which we believe undervalues the company’s earnings consistency and growth prospects. VFC has a long term growth profile similar to Ralph Lauren (NYSE: RL) and Nike, yet it trades at a ~13-16% discount to its peers. Due to its vast portfolio of brands, we believe VFC poses even lower risk than its peers. If the consumer environment does not weaken, we believe there is a good upside to the guidance. Thus we recommend VFC’s stock as a buy.
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The article was written by Sandeep Gupta and edited by Ashish Sharma. Both have no positions in the stocks mentioned above. The Motley Fool owns shares of Aeropostale. Motley Fool newsletter services recommend Nike. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.