VFC - V.F. Corporation: Activist Involvement Confirms Strong Value Proposition (Upgrade)

2023-10-17 19:10:27 ET

Summary

• V.F. Corporation stock has lost tremendous value since early 2021, but recently jumped 14% after activist investor Engaged Capital took a stake in the company.
• Engaged Capital's investment in V.F. Corporation stock has not yet been disclosed, but the activist investor has outlined a comprehensible plan to accelerate value creation and turn the company around.
• In addition to a summary of what went wrong at V.F. Corporation, I will discuss the activist's expected actions and why I believe a dividend cut is among the first steps.
• Finally, I will explain what brought me to upgrade V.F. Corporation stock to "Buy" - despite the looming dividend cut.

Introduction

V.F. Corporation ( VFC ), the apparel and footwear company behind well-known brands like Vans, The North Face, Supreme, and Timberland, seems like it just cannot get any love from investors (aside from short sellers). Since early 2021, VFC stock has lost more than 80% of its value, largely due to poor brand maintenance (especially Vans), portfolio management (high price paid for Supreme), and a very weak balance sheet - the company's Achilles heel in this high interest rate environment. At least that was the case until news broke that activist investor Engaged Capital had taken a stake in the company. At the time of writing, VFC stock is up 14% and up more than 20% from its 52-week low of $15.1.

I have covered VFC stock several times over the past two years, but it wasn't until a while after the dividend cut and after I was convinced the stock price offered a margin of safety that I turned (cautiously) bullish . I started my position in the low $20s, so I'm currently a little underwater - even after the price jump.

In this update, I'll share my thoughts on Engaged Capital's involvement and how I think the situation will play out. Finally, an activist's involvement does not necessarily guarantee a successful turnaround. A long-term-oriented activist could even pressure the board to suspend the dividend - which would likely send the stock plummeting, even though the freed-up cash flow would certainly help reduce debt and dramatically reduce long-term bankruptcy risk.

How Large Is Engaged Capital's Stake In VFC?

News that Engaged Capital LLC ((EC)) has taken an equity stake in VFC was made public through the release of a presentation made at an activist investor conference on October 17, 2023, in which the firm outlined the investment case for VFC's turnaround.

Importantly, a statement detailing the company's investment in VFC has not yet been published on the SEC's website . According to EC's latest 13F filing , the company did not own any VFC stock in its portfolio prior to July 1, 2023. It is possible that the position was built up over the summer when VFC was trading in the $18 to $20 range, but of course it is also possible that Engaged Capital gradually added to its position and took advantage of the recent dip to $15. In any case, the size of the holding is still unknown.

This is an issue, in my view, because it is impossible to assess the activist's conviction, persuasiveness and negotiating power at this time. While EC has presented a concrete plan on how it intends to accelerate value creation (slide 23 ff.), investors will have to wait for the upcoming 13D filing with the SEC before the credibility of the activist can be assessed.

What Went Wrong At VFC According To Engaged Capital?

The activist's main criticism is of VFC's mismanagement by former CEO Steve Rendle, who retired in December 2022 . The picture EC presents in their presentation is a rather bleak one - for example, the company's Denver headquarters is referred to as " Mr. Rendle’s Corporate Death Star " (slide 13). The move from Greensboro ((NC)) to Denver ((CO)) resulted in massive expenses and significant employee turnover. Apparently, Engaged Capital also has inside information from a former executive, who noted that:

" Brands were reorganized to serve the center rather than the center serving the brands. "

VFC Former Executive – slide 14, Engaged Capital Presentation.

On slide 12 of the presentation, Engaged Capital points out four main issues. In addition to the dramatic expansion of the company's cost structure mentioned above, EC says expensive mergers and acquisitions, reduced autonomy of brands to manage key functions, and a lack of marketing and innovation are the main reasons for VFC's poor performance. Suffice it to say that I agree with the activist here, and I have pointed out VFC's poor margins and aggressive M&A in several of my articles. I have never understood why the market - despite the apparent weak operating performance - traded VFC stock at a significant valuation premium for years.

Most disappointing – and EC also noted this in their presentation – is the fact that the VFC Board of Directors has allowed this poor operational performance to continue for years and has failed to act. This is surprising considering that the Barbey family owns 17% of VFC, and it is only reasonable to expect a family trust to have a long-term investment horizon. Frankly, I have never understood how Steve Rendle could be appointed CEO and Chairman of the Board at the same time. In my view, because of the board's oversight role, board members must remain independent of the executives. This is, of course, a problem at many companies.

In any case - and this is what I was hoping for when the news of the activist's involvement broke - EC is quite positive about newly appointed CEO Bracken Darrell. It could well have been that the activist was planning to shake up the entire executive team alongside the board, which might have done more harm than good. And while I wasn't impressed after listening to his first earnings call on August 1, 2023, I think it's important to give the new CEO some time to get a good picture of the situation and formulate a solid plan to turn things around. After all, VFC is struggling not only operationally, but financially as well (e.g., the recent decision in favor of the Internal Revenue Service dealt another blow to the company's balance sheet).

Engaged Capital's Turnaround Plan For V.F. Corp.

As I mentioned in the previous paragraph, EC views the recent appointment of Bracken Darrell as CEO quite positively. Darrell is best known for having led an extremely successful business transformation at Logitech International S.A. ( LOGI ). Granted, an apparel company doesn't have much in common with a technology company, but at the end of the day, both VFC and LOGI design and manufacture goods that must appeal to the end consumer, be functional, and have a high level of brand recognition.

I think the key features of Logitech's turnaround that can be applied to V.F. Corp. are Darrell's aggressive restructuring immediately following his appointment and the decision to reinvest in design and innovation. In Darrell's 10-year tenure, Logitech more than doubled its revenue and increased its EBITDA more than sixfold. EBITDA margin improved from a meager 4.8% in fiscal 2013 to 14.6% in 2023.

This, of course, raises the question of what EC intends to do, given that the right man for the job is obviously already in place.

My interpretation is that the activist will act as an advisor to the executive team to figure out how and where to cut costs and reinvest the savings in innovation and growth. Apparently , EC founder and Chief Investment Officer Glenn Welling has already had constructive discussions with VFC's still-new CEO.

In addition, the activist may intend to get the company to publicly commit to not making any more acquisitions (a big plus in my opinion) and to hire advisors to do a review of non-core divestitures. In my earlier articles, I explained why I would like to see management divest the Dickies brand and the Backpacks business, so that is another point I welcome. Granted, the current high interest rate environment is far from ideal for divestitures at compelling valuation multiples, but I honestly believe VFC has to sell some assets to accelerate debt reduction. In another article , I explained VFC's rather risky situation.

This brings me to a point that may not please income-oriented investors (but please - don't shoot the messenger).

Why An Elimination Of The Dividend Is Likely – And Has Even Already Been Hinted At

Following EC's involvement, V.F. Corporation will likely eliminate its dividend entirely to further accelerate debt reduction. I explained back in late April why even the rebased dividend should not be taken for granted.

On slide 23, EC noted that it intends to " address the capital structure " through the above measures, but it became clear that the activist is prioritizing debt reduction. Engaged Capital also said that management must further commit to "review discretionary capital spending" - in my view, a clear sign that the activist wants VFC to (temporarily) eliminate its dividend.

However, I still consider VFC stock to be a compelling income-generating investment - I expect the dividend to be reinstated after the dust settles and the ship has been righted. I suspect that representatives of the Barbey Trust also have a say in this matter.

I understand the move and, as an investor interested in the long-term success of a company with arguably iconic brands, would likely do the same. Consider that VFC still pays out $470 million in dividends annually, but currently generates only less than $800 million in free cash flow per year. Saving nearly half a billion dollars a year would accelerate debt reduction tremendously. However, while a dividend cut may not be an emotional issue for a relatively new shareholder like myself (who bought VFC as a speculative turnaround investment to begin with), it's definitely a slap in the face to long-term shareholders who have seen the value of their investment erode over time due to arguably poor management.

Conclusion

After a seemingly never-ending selloff, VFC shares finally rebounded 14% after it was announced that activist Engaged Capital had taken a stake in the company. The investment case made in the presentation is sound and convincingly lays out that V.F. Corp. is in the early stages of a turnaround. In my view, the first two steps have already been taken - a dividend cut in February and the appointment of a CEO with turnaround experience in June.

Engaged Capital has not yet disclosed what stake it currently holds in VFC, but a 13D statement to that effect should be filed with the SEC soon. Based on the information contained therein, investors should reevaluate whether EC's stake is indeed strong enough to convince the board - that allowed the strategic errors to occur in the first place - to consider new candidates.

At the same time, I would not over-interpret a still fairly small holding (EC did not have VFC in its portfolio until at least June 30, 2023). The activist already indicated a review of discretionary capital spending, which is a polite way to announce a suspension of the dividend. This would most certainly send the stock tumbling once again, largely due to short-term-focused investors, but also a factor are strategy funds with a mandate to only invest in dividend-paying stocks.

In my view, EC could use this expected slump to further increase its stake. I'll admit that I downgraded VFC stock to "Hold" after the FQ1 results due to the still significant uncertainties and the poor first impression Darrell made on me, but my opinion of the new CEO has evolved over the past 2.5 months. The brand value is undeniable (see, for example, slide 10 of the EC presentation), and with some outside pressure (if it's still needed at all), I'm confident that the turnaround can be achieved. Also, I have watched a number of interviews with Bracken Darrell and must say that I was a bit hasty in my earlier conclusion.

As a result, I am upgrading the stock to "Buy" and plan to add to my still small position (currently 0.5% of the total portfolio) in the event of further weakness, e.g., an announcement of dividend elimination. I will not repeat the results of my stock valuation in detail here and instead refer to my previous articles. Suffice it to say, I think VFC stock is worth at least $44 - which is consistent with Engaged Capital's fair value estimate of $46, which it expects to realize by the end of fiscal 2026.

Thank you for taking the time to read my latest article. Whether you agree or disagree with my conclusions, I always welcome your opinion and feedback in the comments below. And if there's anything I should improve or expand on in future articles, drop me a line as well. As always, please consider this article only as a first step in your own due diligence.

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