Clothing manufacturer VF company (NYSE: VFC) might as well stand for Very Fragile Corporation.
The stock is down more than 60% so far in 2022 and is trading at its 11-year low. industry peers like Under Armor and HanesBrands have had similar tough years, but at least they performed well in 2021. VFC is going backwards for the third time in a row, something that has never happened before.
It was a stunning yet intriguing fall from favor for the company behind The North Face, Timberland, Vans and other popular lifestyle clothing and footwear brands. Interestingly, the stock now offers a 7.3% dividend yield and appears to be finding support in the mid-20s.
But are potential investors getting into a value trap?
Let’s take a look at why the company is being tricked — and whether the plus-sized dividend is really right for income investors.
Why are the shares of VF Corporation so low?
Two quarters into fiscal 2023, VFC has posted some disappointing results. In the first quarter, profits fell 67% year-on-year, lagging far behind Wall Street’s forecast. The recently completed quarter was more of the same. Sales fell for the first time in two years and profits fell sharply.
Supply chain issues have weighed heavily on the company. Distribution sites are backed up and operations are not efficient. This, in combination with higher material and transport costs, has limited the margins. In the recently closed period, the gross margin decreased from 53.9% a year ago to 51.5%.
At the same time, consumer demand for Vans shoes has skyrocketed. The brand’s popularity has faded in 2022 amid an influx of similar (and well-priced) competitors. Inflationary pressures also appear to be causing shoppers to wear additional wear and tear on their property and postpone buying new shoes. Sales of Vans products declined 8% in the quarter.
Vans isn’t the only line with weaker demand. Sales of Dickies clothing, popular with workers, fell 19% in the second quarter. Sales of Timberland boots fell 4%. The combination of slowing sales and rising costs has not been well received by the market.
Is VF Corporation’s Dividend Stable?
At first glance, although sales and profits shrink like cotton that doesn’t need to be washed, VFC’s dividend appears to be in good shape. The company generates sufficient cash flow to meet its short-term obligations and the balance sheet contains a modest amount of long-term debt. However, this comes with a caveat.
During its latest earnings report, VFC announced that its board of directors has approved a cash dividend of $0.51 per share to be paid on December 20. This means that $2.04 in dividends per share must be paid to shareholders over the next four quarters. It also means that more than 80% of VFC’s profits will be declared as dividend.
In general, payout ratios below 50% are considered healthy. In the case of VFC, the payout ratio is high and approaching unsustainable levels. It doesn’t mean the ship can’t be rectified, but profitability will need to pick up by mid-2023, as expected, to make dividend stability less dire.
The good news is that VFC has gone through difficult periods like this before. Recessions, financial crises and recently the pandemic have all caused dividends to be stretched relative to earnings. Through it all, the company has managed to not only maintain, but also increase the dividend-in each of the last 49 years.
Despite the short-term headwinds, management seems determined to maintain its shareholder-friendly reputation, even if it means plowing fewer dollars back into the company for growth opportunities.
Will VF Corporation’s Shares Recover?
The company recently lowered its estimate of full-year earnings per share from $2.65 to $2.45 in the middle. Like other apparel manufacturers, management sees weaker economic conditions ahead that are likely to impact demand for its gear at brick-and-mortar stores and e-commerce sites.
At 11x this year’s earnings, VFC is trading below the industry average P/E. Still, the multiple is worth considering the recent performance and bleak near-term outlook. The Street forecasts flat sales in the main shopping period before the holiday season and a decline in annualized earnings per share for the next two quarters. Earnings growth is not expected to occur until fiscal year 2024.
VFC still has some supply chain bottlenecks and macro issues to work through. However, if these challenges improve, the stock could be attractive as a high-yield turn around play. There will be a recovery, but probably not for at least a few more quarters. For now, income investors are better off window shopping until returns of 8% or P/E below 10 come in – and ideally both.