CONCLUSION: We think that VFC succeeded in focusing investors on the big picture at its Analyst Day, but there is still a massive 'trust me' element to this model. Granted, management has earned the benefit of the doubt, but a lot needs to go right to hit its targets. We think the bigger question people are not asking is why this company has five different Brand Coalitions and is operating an 'above average' portfolio, instead of downsizing to a portfolio that is truly 'great'. After all, it's a seller's market.
We've read through a lot of commentary about the VFC analyst day, and as quantitatively concise as the company's targets are, there were elements of the presentation that we don't think are well represented in the risk/reward. The general sentiment sounds something like a) Same 'ol great quality management, b) aggressive 10% global sales growth targets (presuming acquisitions come through), c) a hockey stick acceleration in EBIT margins from 13.5%-16.0%, d) $18.00 in EPS in 5-years (better than the $17.00 in '17 that they are setting as 'official' goals), and e) a 300-400bp improvement in ROIC.
Presuming the company hits its goals, the stock is trading at 10x that earnings number today, or 17x 2013. IF you believe these targets and think that current peakish multiples can hold for another 5-years, you're looking at about a $300 stock in 5-years (1827 days, but hey, who's counting?), or a 10-12% CAGR in VFC's stock. That's nice, but a lot needs to go right for it to happen, and the end result is a return that we'd consider 'about average'.
There's something about the crux of the presentation that did not sit well with us, and that's the lack of detail around how VFC is going to achieve these targets. We understand that it's hard to give such specific detail for a company with a portfolio of 27 brands. But there was very much a feel of 'trust us…we'll do it.' In fact, their overall tone was about as bullish as we've heard any management team in a long while. And when we marry such a bullish tone with high yet unsubstantiatiated targets (that the Street will blindly bake right into their models), it makes us a bit weary.
In fairness, this is a management team that has earned our respect in executing upon its promised goals. So when they say they're going to do something, it means they're probably going to do it. But adding $5.2bn to a $5.9bn Outdoor and Action Sports business over just 5-years? That's a big big number, and the supporting context was sparse.
The BIG Question
Regardless of the targets, here's a bigger question for us… The company plans to add $6.4bn in revenue over 5-years. Yet $5.2bn, or 81% of that is in the Outdoor and Action Sports arena. They are making it clear that the Outdoor business is diversifying both geographically and seasonally to maximize growth potential while mitigating volatility. It accounts for 55% of sales today, and within 5-years' time should be 64% of sales. That's great. But the simple question is…"Why not 100% of sales instead of 64%? Why do they have the other four brand coalitions a all?"
We could justify being in the denim business. It owns two of the most stable and steady brands in the business in Wrangler and Lee. In addition, it has a mid/high-teens margins and the highest ROIC at the company since it owns a significant portion of its own manufacturing facilities.
But as for its' other three Coalitions? Contemporary (7 for all mankind), Sportswear (Nautica), and Imagewear (Majestic)… why is it in these businesses at all? The brands are all what we'd consider 'average to above-average.' But we're only interested in owning brands that are truly 'Great'. VFC has three great brands. The North Face, Vans and Timberland, and they are all in the Outdoor Coalition. The other brands that are on the bench as being 'potentially great' (such as Smartwool, Napapijri, Reef, and Lucy) also happen to be in the Outdoor group.
We're not suggesting that VFC gets out of the 'portfolio of apparel brands' business. But simply that a more focused 'portfolio of Outdoor/Action Sports brands' might make a lot more sense. At a minimum, we'd pay a higher multiple for it. For example, the company is now trading at about 14x TTM EBIT. Two points of multiple expansion on a smaller, but more focused portfolio of outdoor and Jeanswear brands yields an immediate return 14% above current levels -- and that's before considering what we think would be between $1.5bn and $2bn ($13-$18/share) in proceeds from the rest of the portfolio. This is wishful thinking, as we don't think VFC would ever consider going there. But this is where we think the most value would be created for shareholders.