VFC: EPS and Inventory Still Too High

We've been negative on this one for a while, though admittedly wish we were louder into this earnings report.  Anyone who thinks that a global company with a portfolio of core cash flow generators layered with younger growth brands could escape the worldwide recession is out to lunch.  Now it's time for VFC to play catch up with the rest of their apparel brethren and take their lumps on margins while aggressively cutting inventories. 

 

The Street has cut numbers substantially for the next quarter, but the full year appears to be settling out in the middle of management's provided range of $4.70 to $5.00.  We think these numbers are still too high.  We're getting to something closer to $4.50.  The inventory clearing process (while ultimately positive for FCF) will hurt gross margins big time over the next couple of quarters.  With 50% of the problem lying in the European denim business, we think it will take some time to work through the inventory.  Last time we checked there weren't many major off-pricer's in Eastern Europe or Scandinavia.  Admittedly, 4Q is still a toss-up at this point given the easy margin and topline compares that resulted from the most volatile shopping season on record - but we don't have the confidence that management can proactively drive the entire portfolio this far out when it has so much on its plate. 

 

However, a couple of points are clear to us:

 

Inventories are coming down (-4% in Q1, should be -10% for the year) but it will take some time to get to manageable levels. Along the way, there will be gross margin pressure that likely persists throughout the remainder of the year. It does not take much GM% erosion to get to management's guidance. But forced inventory reduction could easily take out an extra point or two. Remember, VFC has been an apparel conglomerate for a number of years disguised as a growth company. Meaningful inventory reductions have not been part of the equation here for a long time.

 

Newer brands are finally showing signs of weakness as evidenced by a decline in 7 For All Mankind, negative sales in the outdoor segment, and negative mid single- digit comps in the newly-built retail operation.

 

Cost savings remains on track, but even cutting $100mm this year cannot offset leverage loss on the top line. This is not the kind of company where it pays to cut costs in a meaningful way. Portfolios of retail past (the JNY's and LIZ's of the world) virtually destroyed their respective businesses by cutting too much muscle.

 

While not the biggest takeaway from the quarter, we found it interesting that 7 For All Mankind reported sales declines, even with new store growth helping to grow the topline. We're not sure if it makes sense to continue to roll out high cost retail flagships when customers don't seem as interested these days in $200+ denim. We realize the brand is still evolving but it's never a great sign when a growth vehicle stops growing. Unfortunately, the success of The North Face is extremely difficult to replicate...

 

We wonder how quickly VFC can layer on acquisitions to offset the focus and reality of slowing core brands and maturing young brands? Is the long rumored DC shoe deal going to re-emerge? It better... (and at a fire-sale price).

VFC: EPS and Inventory Still Too High  - vfc sigma


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