VF Corp to Accelerate Deleveraging With Savings From Substantial Dividend Reduction
VF Corp's stock is down over 5% in after-hours trading following a disappointing update from the apparel maker that included the withdrawal of full-year guidance and a substantial 70% dividend cut.
Efforts to turn around the company's largest brand, Vans (over 30% of revenue), continue to falter, with sales down nearly 25% last quarter, and the iconic skate shoe is not expected to improve in the back half of this fiscal year.
Additionally, the important American wholesale channel, down 11%, remains weak as retailers have scaled back purchases to address and rectify the heavy inventory issues that plagued many over the last year.
Overall, these continued challenges have created a difficult backdrop for the newly appointed CEO to balance returning the company to growth while deleveraging the balance sheet back to the firm's target of around 2.5x.
Source: Simply Safe Dividends
We cautioned last August about these competing needs and the potential impact on the dividend (emphasis added):
In an effort to navigate these challenges, VF Corp has brought on board a new CEO credited with turning around the tech hardware company Logitech during his tenure as President and CEO over the last decade.
Enlisting an external turnaround expert could prove a catalyst for restoring VF Corp to its pre-pandemic glory. However, this move also implies the board is receptive to substantial changes, potentially entailing a revision of the firm's capital allocation strategy – including the dividend.
With the payout reduced by 70%, VF Corp will free up around $325 million annually to help pay down the roughly $1.75 billion of notes (over 25% of total debt) that mature over the next 18 months (management stated it intends to pay off those debt maturities, not refinance them).
Furthermore, management stated today that reducing leverage is now the firm's top priority. And in bringing down debt levels, "everything is on the table, and there are no sacred cows."
While VF Corp withdrew earnings and sales guidance for the fiscal year, the firm projected it would generate $600 million in free cash flow (FCF), down from the $900 million forecasted last quarter.
That FCF estimate easily covers the reduced annualized payout of $140 million while providing extra capital for management to continue reducing debt. VF Corp also holds $500 million of cash it can use to help meet its maturing debt obligations.
That said, the company's future remains murky as new leadership works to revive the core Vans brand while defending other cash cows like The North Face. With consumers spending less on discretionary goods, this is a tough environment for a turnaround.
The future becomes blurrier still with a couple of activist investors (Legion Partners and Engaged Capital) recently taking an interest in the company. They are pushing for cost-cutting and the divestiture of non-core brands, which they believe could help the stock double within three years.
New leadership, debt reduction, activist investor involvement, and a beaten-down valuation provide an interesting foundation for a turnaround story. But as VF Corp shareholders, this guidance reduction and dividend cut are the final straw for us.
Our hopes that the firm was nearing a turnaround point appear increasingly misplaced as Vans continues to underperform and cash flow shrinks.
It's hard to feel confident that the brand doesn't have deeper problems that could cement the company as a value trap, and a CEO coming from the tech hardware industry faces a steep learning curve.
In our Long-term Dividend Growth portfolio, we will begin looking for replacement ideas for our small position in VF Corp.
Investing in fashion brands is notoriously difficult and something we have long avoided. But VF Corp seemed like an exception given the long track record of growth it had achieved with Vans and The North Face, plus the successes of other brands that helped fuel annual dividend growth for over five decades until this year.
In hindsight, VF Corp has proven an example of how fast a company's fortunes can change despite a stable history, and how the need to reduce debt can quickly be prioritized over the dividend when times get tough.
While we do not plan to remain invested in VF Corp's ongoing turnaround story, we will continue monitoring the company's progress and provide updates as needed.
