VF Corp's Dividend Faces More Pressure as Vans Struggles Continue; New CEO to Lead Turnaround

VF Corp's much-anticipated turnaround is taking longer than expected as slowing sales from Vans, the apparel firm's largest brand (>30% of revenue), continue to weigh on the company.

Sales fell 8% last quarter and have particularly been pressured by the firm's wholesale partners (>50% of revenue), who have scaled back purchases to address and rectify the heavy inventory issues that plagued many retailers over the last year.

Promotional activity will likely remain elevated as inventory reduction continues and retailers operate more cautiously when restocking products.

This shift in wholesale purchasing habits is stunting a potential rebound for Vans and other notable VF Corp brands like Dickies and Timberland, which have also seen sales contract.

Fortunately, The North Face brand has proven resilient to these challenges and continues to experience double-digit growth.

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.

While management reiterated its intent to maintain the payout during August's earnings call, they also emphasized that deleveraging was the firm's "number one financial objective" and aim to reduce gross debt to about 4.0x earnings by fiscal year-end from the current 4.8x. 

This is an aggressive yet attainable goal if earnings recover 10% over the next year as management expects, and VF Corp sticks to its plan to direct all of its post-dividend free cash flow towards debt reduction.

The firm might also be able to accelerate deleveraging with the proceeds from some planned property sales estimated to generate around $100 million and the possible divestiture of its global packs business.

Additionally, a pending tax case could provide a cash infusion of $876 million (an amount equivalent to VF Corp's free cash flow expected this year) if a judge rules in favor of the apparel maker, according to S&P – which downgraded the firm's credit rating to BBB in June.

While these one-off events could have a significant impact on helping VF Corp reach its deleveraging goals, which include a longer-term leverage ratio target of 2.5x, each outcome remains largely outside the company's control.

In contrast, if an earnings recovery fails to materialize management could consider suspending the dividend, which is projected to consume half of VF Corp's free cash flow, unlocking almost $500 million annually that could assist in reducing the firm's $5.8 billion of book debt.

Simply put, VF Corp has a pathway toward meeting its deleveraging goals – but the firm has little flexibility to absorb any more setbacks.

Recognizing the continued performance challenges at Vans and the firm's stated deleveraging goals under new management, we are adopting a more cautious stance and downgrading VF Corp's Dividend Safety Score within our Borderline Safe bucket from 60 to 50.

Should the firm face any additional setbacks with its earnings trajectory or deleveraging progress, we would consider another downgrade.

That said, we remain hopeful the firm's troubles have peaked and that VF Corp is nearing a turnaround point. We plan to maintain our VF Corp position in our Long-Term Dividend Growth portfolio so long as earnings improve from here and Vans avoids secular decline.

However, the road ahead may continue to be bumpy over the next year or two as inventory levels normalize, consumer spending patterns shift, and turnaround efforts accelerate.

Given VF Corp's recent performance, we will continue closely monitoring the company and provide updates as necessary.