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It’s no surprise that VF Corporation’s stock (NYSE: VFC) is currently at a 10-year low. A U.S. Tax Court ruled against Timberland in a decision that is likely to cost the company $500 million. It overpaid to acquire Supreme in 2020, which was written down by $313 million in FY2023. Finally, the company’s inventory levels nearly doubled from FY2022 to FY2023, and much of it needed to be written down or discounted away. All of these factors led to a dividend cut, which not only shattered investor confidence, but also forced dividend-focused ETFs to dump the stock and stripped the company’s status as a dividend aristocrat (50 years of consecutive dividend growth).

The recent slew of negative press, resulting from a mix of mismanagement and factors outside of the company’s control, has led to a justified re-rating of the stock lower. However, the market’s reaction has been excessive. The fall of GAAP earnings in FY2023 can mostly be attributed to the impairment of goodwill from the Supreme acquisition mentioned earlier, which was a non-cash expense. FY2023 revenues were essentially flat, decreasing 2% to $11.6 billion (in constant currency, it increased 3%). Looking ahead, FY2024 earnings guidance of $2.15 at the midpoint puts the stock at a valuation of less than 10 times earnings. The stock has not been this inexpensive in years, which goes to show the extent to which the stock has fallen—it's gone from a peak of nearly $100 to less than $20 today.

VF’s portfolio of brands, which has a focus on outdoor and streetwear brands, is favorably positioned for the long term in my opinion. Additionally, the company stands to benefit from international expansion and the rise of direct-to-consumer channels (including e-commerce), which have higher margins than other channels and also provide with VF increased data for analytics. In the short term, VF is expected to experience a reversal of the headwinds that previously afflicted the business. Factors such as reduced freight costs, leveling off of inventory levels, and the appointment of a new CEO (who comes from Logitech) are anticipated to work in VF's favor. 

VF’s stock is a clear case where the market has erroneously extrapolated recent trends into the future. In my opinion, the sensible thing to do for value-oriented investors is to back up the truck on VF shares while it is under $20 per share.  

The stock is a new addition to my portfolio, and one of my highest conviction ideas at the moment. I am very bullish on the name.

The Business 

A house of brands, VF has adopted a low-publicity profile that aligns with its nondescript name. Its current corporate strategy is not to develop its own brands; instead, it focuses on acquiring niche brands that show an attractive Return on Invested Capital (ROIC) and then growing them into mainstream adoption (management has a self-proclaimed goal of getting all brands to $1 billion in annual sales). This approach allows VF to utilize its expertise in apparel and also leverage its SG&A, Sales & Marketing, and Distribution costs across all of its brands. As VF onboards new brands, it aims to realize cost savings by finding synergies in the combined business’ operations. 

Historically, VF's active management of its portfolio of brands means it has also occasionally “trimmed the fat”: the company divests underperforming brands when appropriate. Notably, the company successfully sold its lower-margin workwear brands in 2021. And, in a significant move in May 2019, VF spun off jean brands Lee and Wrangler into publicly-traded Kontoor Brands ($KTB). Additionally, VF has divested brands including 7 for All Mankind, Ella Moss Splendid, Nautica, and Reef since 2016. Currently, management has also indicated they are exploring strategic opportunities for JanSport, Eastpak, and Kipling, which Wall Street analysts estimate would fetch around $500 million in a sale.

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After the spin-off of Kontoor, VF's three main segments are Outdoor, Active, and Work.

With its remaining portfolio, an astonishing 84.5% of VF’s FY2023 sales come from its “Big 4” brands: Vans®, The North Face®, Timberland®, and Dickies®. When Vans was acquired in 2004, it was a niche skateboarding and action sports brand in California with around $330 million in annual revenue. Under VF, Vans’ demographic has expanded and ended FY2023 on a $3.7 billion run rate (32% of total revenues). The North Face was nearly bankrupt in 2000 when VF made a bid to acquire it for $25.4 million. It ended FY2023 with sales of $3.6 billion (31% of total revenues), just a hair behind Vans. Timberland was acquired in June 2011 for $2 billion and accounted for $1.8 billion (16%) of FY2023 total sales. The newest addition to the “Big 4” is Dickies, which was the largest brand in the Williamson-Dickie portfolio that was acquired in 2017 for $798.4 million. The Williamson-Dickie acquisition also came with other brands like Workrite, Kodiak, Terra, and Walls; however, most of those were sold off in the workwear brands divestment mentioned earlier. The Dickies brand brought in $725 million of revenue in FY2023. 

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VF has an enviable business mix: it is well diversified by segment, channel, and region.

Absent from VF’s “Big 4” is Supreme. In hindsight, I believe the $2.1 billion acquisition of Supreme in 2020 was a mistake. The purchase was made at too demanding of a price, and more importantly, was not a good fit for VF.

Cultural Clash at Supreme 

Supreme was founded in 1994 in New York City and has become an icon in the streetwear fashion industry, known for its influence on “arts, music, and skate culture.” The brand is beloved by its fans and its products command operating margins of 20%, better than any other brand in VF’s portfolio and near that of luxury goods (think brands in the LVMH portfolio). Considering Supreme’s substantial cultural influence, one may be surprised its actual sales numbers are quite small: less than $500 million at the time of acquisition in December 2020. All of these factors combined—impressive margins, an almost cult-like following, and a large runway for sales growth—made Supreme a good candidate for VF’s portfolio on paper. However, nearly three years after the acquisition, it is apparent Supreme is an odd one out in the VF portfolio. 

Supreme is known for “drop culture” and the company embraces the hype and quirkiness around its products (e.g., see the time it sold bricks with its logo, as well as other non-apparel items it’s released). Fans adore the status symbol Supreme products convey—so much so there is even a significant resale market. Supreme's distribution model is almost exclusively direct-to-consumer. It operates a limited number of physical stores (less than 20) and instead delivers the majority of sales through its online presence. 

In contrast, VF’s brands are somewhere in between mass-market and high-end; for example, The North Face and Timberland often command a premium, but the price point for Vans is comparable to other streetwear/casual shoes. VF’s distribution is also much more varied, with sales split 55/45 between wholesale and DTC. In the wholesale channel, VF’s brands are mainly marketed to consumers in “specialty stores, national chains, mass merchants, department stores, independently-operated partnership stores and with strategic digital partners” (Form 10-K). In addition, VF sells inventory in both premium locations like $SPG-operated malls and value locations, including department stores like Nordstrom, Macy’s, and Dillard’s. None of VF’s other brands have a cult-like following: though one would be hard pressed to find Timberland boots for sale on eBay, there are hundreds of Supreme items listed. Given the fundamental differences between the brands, VF’s acquisition of Supreme was quite a departure for management.

But perhaps the most egregious aspect of the entire acquisition was the unruly $2.1 billion price tag. In 2017, three years before VF’s bid, Supreme sold 50 percent of itself to the Carlyle Group for $500 million, giving it a valuation of $1 billion—and even that was multiples higher than its valuation several years earlier. In FY2023, Supreme brought in $523 million (or approximately 5%) of VF’s total sales; compare that with Dickies, which contributed 6% of VF’s sales and was bought for $798.4 million. Granted, Dickies was bought in 2017, and sales have only modestly grown since, but the Dickies purchase also came with other smaller brands in the Williamson-Dickie portfolio. 

Risks

The integration of Supreme into VF poses the largest risk to the business. In addition to the culture mismatch discussion earlier (namely Supreme’s use of frequent and limited “product drops” and its emphasis on DTC), there are signs Supreme’s allure with its loyal fan base is starting to fade. While VF has not released official production numbers, fans report an increase in products (in both quantity and SKUs), which has led to items no longer selling out on “drop” day. Before VF’s acquisition, Supreme’s store famously had lines wrapping it for blocks and items would sell out almost instantly on drop day—with the sale items appearing on resale sites for a higher price. Flooding the market with more supply has caused brand dilution. 

VF has also undertaken little physical expansion, only opening up 2 new stores in San Francisco, CA and Milan, Italy since buying Supreme. While the pandemic indeed threw a wrench in plans, it is disappointing to see how little effort management has put into a brand it paid such a premium for. VF’s management is used to dealing with brands more geared towards the mass market; Supreme’s products are premium, almost “exclusive,” and management has not played its cards correctly.

That said, there are some silver linings. First, management has accepted the shortcomings at Supreme by impairing $313 of goodwill ($165.1 million to the Supreme reporting unit and $148.0 million to the indefinite-lived trademark intangible asset). Second, the market has duly made it clear it doesn’t like the Supreme acquisition (and other management missteps) but its discontent is already priced into the stock at the expense of shareholders who held from 2020 to 2023. Lastly, Supreme still has a fiercely loyal fan base and has a clear runway for growth, especially internationally. Specifically, in the Q3 2023 earnings call in February, the interim CEO bragged about the strong fan base in China and stated VF has “a strong right to win in [the Chinese] market.”

While the acquisition doesn’t seem to fit into VF’s existing portfolio, and the mismatch in distribution and price/volume, new investors in VF should view Supreme as a brand with great potential and a great contender for the large and growing streetwear apparel market.

Beyond the operational challenges at Supreme, VF’s business faces little company-specific risk. In terms of the sourcing of raw materials, “no single supplier represented more than 6% of cost of goods sold during Fiscal 2023” (Form 10-K). In addition, the manufacturing of the vast majority of products is outsourced to approximately 300 independent contractors in 35 countries, removing VF one step further from the “sweatshop” working conditions allegations that have hit Nike and Lululemon in recent years. Lastly, there is little customer concentration: “sales to VF’s ten largest customers were approximately 15% of total revenues in Fiscal 2023, with our largest customer accounting for approximately 2% of revenues” (Form 10-K).

4th Quarter Results and FY2024 Guidance

VF’s full-year results were expectedly sluggish. Notably, sales at Vans, the biggest contributor to revenues, declined by 14%. Even Supreme’s revenues also dropped in FY2023. One of the only highlights was the 11% sales growth at The North Face. 

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The strong dollar significantly hurt VF’s gross margins, which fell from 54.8% in FY2022 to 52.6% in FY2023; to this point, while FY2023 revenues decreased by 2% on a GAAP basis, they increased by 3% in constant dollars. Operating margins dropped even quicker, from 13.1% to 9.8%, mostly a carry-over from the gross margin decline but also 90bps of operational deleveraging.

However, the market is a forward-looking vehicle and the narrative is more optimistic when looking at FY2024. In Q4, VF reached its goal of sustainably reducing inventory by $300 million. Management cited that while inventory levels “remain[s] elevated… trends are good,” implying there will be far less discounting and no more inventory write-downs. In addition, FY2024 is when the company will realize cost savings from cheaper ocean freight and the 800 employee reduction completed last year.

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The FY2024 guidance presented at the Q4 earnings call affirms both gross and operating margin expansion, as well as (constant currency) revenue growth. Management singled out APAC as the fastest growing (anticipated to grow double-digits). While these numbers are disappointing in absolute terms, they are an improvement from the previous two years and quite decent relative to how the stock is priced today.

Although shareholder votes for VFC's 2023 AGM are currently trading on Shareholder Vote Exchange, interest appears muted, suggesting that there is minimal interest from activist investors at this point. As a consumer cyclical company at a cheap valuation, it's certainly a fair target for activists and we should continue to monitor any such developments.

Valuation  

If management meets guidance, the current stock price of less than $20 implies a forward price to earnings of less than 10x and a price to free cash flow of 8x. Pre-pandemic, VF traded for a premium of 20x to 30x earnings as investors bid up the stock for its track record of dividend growth and its portfolio of quality brands.

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The FASTgraphs valuation tool makes this point clear: the black line shows the historical stock price, the orange line shows the implied price given an earnings multiple of 15x, and the blue line represents the implied stock price given the stock’s average historical P/E. Since the start of the chart in 2002 and through 2012, the stock was trading fairly with fundamentals. However, from 2012 until the pandemic, investors internalized the company’s track record of earnings growth and consistent dividend raises and bid up its valuation to an unreasonable level. It is only after the post-pandemic sell-off that VF’s stock has dropped below its historical average.

In addition to the valuation metrics that FASTgraphs provides, I have also constructed a discounted cash flow model, which uses a weighted average cost of capital (WACC) of 9.5%—reasonable for an established business like VF (if 9.5% seems elevated, consider interest rates are no longer near 0%). (While I do not want to make my DCF models public, I would be open to sharing them through a direct message.) 

As a point of reference, here are historical growth and operating margins from 2018 to 2023: the Outdoor segment grew at 7% and had margins of 12%; Active grew at 5% and had 19% margins; and Work revenue was flat and margins hovered around 9%. 

I modeled two cases: a tragic case and a realistic case. In my tragic case, I used very pessimistic assumptions of 0% growth in all segments and operating margins 2% worse than all of the segment’s 5 year historical average. In the tragic case, I arrived at an equity valuation of $24 per share (still below the current market price). In my realistic case, I modeled the following: on average, 5% growth and 12.5% margins for Outdoor, 6.5% growth and 20% margins for Active, and no revenue growth and 9% margins for work. In the realistic case, I arrived at a final valuation of $48 per share.

Clearly, the market is pricing in negative revenue growth and worse margins for the business. I strongly contend with both points. 

Future Growth Opportunities 

As mentioned earlier, VF’s brands have a particular skew towards outdoor and streetwear, which are currently two of the fastest-growing segments in apparel at the moment (along with athleisure). While VF’s wholesale distribution channel faces challenges, growth in the direct-to-consumer (DTC) channel will more than make up for that in my opinion.

55% of VF’s revenues came from wholesale and other non-DTC channels, but those channels cannot be counted on as the future of many department stores is in flux. The decline of physical retail not only hurts VF’s sales, but in the event of store closures, inventory is often liquidated at below market price. This is why the investments VF’s made years ago in the DTC channel, including e-commerce, are bearing fruit.

The business mix shift towards DTC has steady momentum behind it (DTC made up just 29% of revenue in 2017 and is now 45% of revenues) and is expected to continue. For VF, e-commerce transactions taken directly on a brand’s website are part of the DTC channel. 43% of VF’s DTC business and 19% of total VF revenues in FY2023. Transactions that take place in VF-operated stores and on its brands’ websites command higher gross margins than other channels. In addition, VF is better able to cater experiences to its shoppers, in contrast to non-VF-operated stores where VF’s products are ranked against those of other brands and often commoditized. Lastly, VF is also able to better gather data on its consumer, which it can use for data analytics and improving the loyalty program.

VF is also in the middle stages of international expansion. In Fiscal 2023, VF derived 58% of its revenues from the Americas, 29% from Europe, and 13% from Asia-Pacific. Consumer demand for “Western” fashion is especially strong in APAC, and why management is optimistic it can grow revenue double-digits in FY2024. While growing sales internationally invariably lead to wild fluctuation in FX, most transactions are incremental. This is in contrast to sales growth in the DTC channel, which cannibalizes sales made in-store.

Conclusion

VF’s strategy of acquiring up-and-coming brands and growing them into businesses with $1 billion+ in sales was one that Wall Street loved: from the acquisition of The North Face in 2000 until before the pandemic, the stock went from $5 to nearly $100 per share. However, recent ill-fated decisions around the Supreme acquisition and building excessive inventory in 2021/2022 have investors doubting the company’s future potential.

However, I believe the market’s view on the company is misguided and I believe the stock presents an attractive entry point for investors. Company insiders agree. Since December of last year, there have been five insider transactions, all worth $100,000 or more, by separate people. Zooming out to all transactions since 2022, we see even more buying activity and only one sale (substantially less nominally than the buys).

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I also believe investors should give the incoming CEO, Bracken Darrell, the benefit of the doubt. Bracken Darrell comes to VF from Logitech, where he was CEO since 2013. While I was initially skeptical of Bracken Darrell because he didn’t have any experience in apparel, he did spend time at Procter & Gamble and Whirlpool before joining Logitech. And in the decade he presided over the computer peripherals and software company, the stock price nearly 10x’d, from $7 in 2013 to $60 today. I was also perplexed why Darrell would leave to join VF, currently a smaller company than Logitech in terms of market cap. But that’s explained by Logitech’s strong performance and VF’s fall from grace—it was only recently that Logitech overtook VF’s market cap. 

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There is immense uncertainty about the economic climate in the US, with some pundits saying soft landing, others saying we’re in a “rolling recession,” yet others predicting a financial crisis. VF’s main demographic, young adults with disposable income, will soon be resuming student loan payments. However, VF’s house of brands is well diversified in apparel categories and price points. They are also strategically positioned, both domestically and abroad, to resonate with shoppers. Weakness in any one geography will not disproportionately impact VF, and the company’s brands have a clear runway for growth in unsaturated markets like APAC.

Through the 2010s, VF stock was priced at a premium, seemingly disconnected from the underlying fundamentals. However, the extreme sell-off experienced after the pandemic has now disconnected the stock from its fundamentals—this time in the opposite direction. While VF made for a poor investment in recent years, its current circumstances present a timely opportunity for new shareholders to acquire its premier apparel brands at a highly reasonable valuation.

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