VF’s Strategy; Why it is Consistent with the Competitive Environment

VF filed its 10K annual report with the SEC three days ago, so I’ve been able to get a more complete picture of their performance for the year and quarter. You can see that report here. As you probably know, VF is a large consumer conglomerate that owns 30 brands including Vans, The North Face, Reef and Timberland which are part of its Outdoor and Action Sports segment. Its other segments include Jeanswear, Imagewear, Sportswear and Contemporary Brands. We’ll talk about the general strategy and focus on Outdoor and Action Sports. 

Pieces of the Strategy
Revenue for the year rose 15% as reported from $9.46 to $10.88 billion. Not following my usual process, I want to jump right to the balance sheet and report that inventory fell 6.8% over the year from $1.45 to $1.35 billion. Partly what’s going on here is that they are getting their Timberland acquisition (purchased in September of 2011) under control. But typically, you’d expect inventory to rise some with sales and when it’s doesn’t, it’s a good thing.
Now let’s jump to page 1 of the 10K to see what their broad strategy is:
“VF’s strategy is to continue transforming our mix of business to include more lifestyle brands. Lifestyle brands connect closely with consumers because they are aspirational and inspirational; they reflect consumers’ specific activities and interests. Lifestyle brands generally extend across multiple product categories and have higher than average gross margins.”
Connection with consumer and higher margins. No wonder they like outdoor and action sports.
Meanwhile, over in the conference call, VF Chairman, Chief Executive Officer, President, Member of the Finance Committee and for all I know Czar of all the Russians Eric Wiseman talks about their other focuses.
“…an obsessive focus on continuously improving our operational capabilities to drive growth and strong consistent returns to our shareholders; and finally, a highly efficient supply chain that includes owned and sourced manufacturing, which gives us unparalleled structural advantages, including product innovation, speed to market, low cost and outstanding quality. Individually, any one of these strengths would be an enviable asset for any company to have. Yet together, in concert, they’re at the center VF’s DNA and what allows us to be so successful.”
Keeping the supply chain efficient is no simple task. From the 10K:
“On an annual basis, VF sources or produces approximately 450 million units spread across 36 brands. VF operates 29 manufacturing facilities and utilizes approximately 1,900 contractor manufacturing facilities in 60 countries. We operate 29 distribution centers and 1,129 retail stores. Managing this complexity is made possible by the use of a network of information systems for product development, forecasting, order management and warehouse management, attached to our core enterprise resource management platforms.”
I don’t want to put VF on a pedestal here. There’s a never a section in the press release, conference call or SEC filings called “Places where we really, really screwed up.” It does not always go smoothly. 
Nor is it ever finished. I wouldn’t be surprised if a big piece of CEO Wiseman’s job was to make sure the whole organization is thinking about incremental ways to make things better. Everybody should be empowered to ask, “If we combine production for these two brands, can we save $0.03 a garment?” “If we make it at a factory we own, will the faster turnaround time mean lower total inventory that offsets the higher cost per piece?”
Sales increases are swell, but it’s nice to have ways to improve your profitability by increasing gross margin dollars or controlling expenses if they aren’t easy to come by. And it’s good to have a balance sheet that lets you invests in efficiencies- especially if your competition can’t.
VF is trying to do what I’ve been arguing in favor of for years. No wonder I like them.
The Outdoor and Action Sports Segment
This segment generated $5.87 billion, or 54%, of VF’s revenues for the year. It had an operating profit of $1.02 billion, representing 58% of total operating profit for VF, and an operating margin of 17.4% (higher than other segments with Jeanswear being second at 16.7%). That margin is down from 19.9% in 2010 and18.2% in 2011. The decline is largely due to Timberland.
Segment revenues grew 28.6% from $4.56 billion the previous year. Jeanswear is second at $2.79 billion representing 26% of total revenue. It was up only 2.1%. Growth of 6.3% by Sportswear was the second fastest segment growth.
But there’s a caveat. Of that 29% growth, 19% was the result of the Timberland acquisition and only 10% was organic (from the existing brands). But 10% organic growth is way better than any of the other segments did, except for “other” which grew 12.5% but was only $125.5 million in revenue for the year. 
The North Face is the largest brand in the segment, with Timberland second and Vans third by revenue. There are 100 VF operated North Face stores worldwide. Timberland has 200 stores and Vans 350.
Domestically, the whole segment was up 21% but 12% of that came from Timberland. International revenue was up 37% with Timberland representing 26%.
The North Face and Vans grew globally 9% and 23% respectively in 2012. Their direct to consumer business, including new store openings, comparable store sales and online, increased 13% and 18% respectively. In 2013, Van’s revenues are expected to be up 20% and The North Face up in the “high single-digit” range. Timberland’s revenues are projected to be up in the “mid-single-digits.”
Outside of the Americas, Vans revenue growth was in excess of 30% in constant dollars. It was up 60% in constant dollars in Europe and 20% in Asia. Direct to consumer was “a big part” of this growth.
We also learn that Reef’s revenues were up 17%, though we aren’t told anything about what its total revenues are. This is significant only because they haven’t said anything about Reef in the past probably because there was no good news to report. 
VF’s total capital expenditures in 2012 were $252 million. Of that total, $156 million or 62% were in Outdoor and Action Sports.
Some Overall Numbers
VF’s $10.9 billion of 2012 revenue generated $1.09 billion in net income. They spent $585 million on advertising. International revenue was 23% of total. 5% was organic and 18% due to Timberland. Direct to consumer revenue rose 25%, but 15% of that was Timberland. It accounted for 21% of total revenues. They opened 141 retail stores in 2012 and expect to open 160 in 2013. Gross margin improved from 45.8% to 46.5% “…primarily due to the continued shift in the revenue mix towards higher margin businesses, including Outdoor & Action Sports, international and direct-to-consumer.” Hmmm. Sort of seems to leave out North American wholesale business. 
For the last quarter of the year, VF’s revenues were $3.03 billion and it earned a net profit of $334 million. No details provided.
Okay, don’t stop reading here just because I’m going to talk about pension accounting. This is important. VF made a $100 million voluntary contribution to its pension plan during the year. What’s going on in the world of pensions? Not just at VF. 
How much you need to contribute to a pension plan obviously depends on a whole bunch of assumptions involving how many people will get pensions for how long and how much you’ll earn on the money invested in the plan. In 2012, VF assumption was that the rate of return on its pension assets would be 7.5%. They’ve reduced that to 7% in 2013. At the same time, they’ve “…altered the investment mix to improve investment performance.” I won’t go into the details, but from their description, I’d conclude they’ve increased the level of risk in their portfolio to try and earn that lower targeted return.
There’s a lot of this going on. Company and government pension plans have found themselves underfunded at least partly because they’ve been stubbornly unrealistic for years about what they could expect to earn on their pension assets. I think they’re still unrealistic. If they reduce the expected rate of return, the required contributions to the plans go up.
This is going to be messy. Not for VF necessarily, because they earn a lot of money and can afford to contribute to their pension plan, though obviously it will have some impact on the earnings per share. You’ve already seen some governments have problems in this area. Just be aware is all I’m saying.
The Evolution of VF
The Outdoor & Action Sports segment is presently the driver of VF’s success. They’ve acknowledged that in the description of their strategy quoted above that describes the kinds of brands they want to own. If they can improve Timberland’s performance, this will be even truer. As a company, they’ve changed their focus through buying and selling of brands. I don’t expect that to change. They say it won’t. They sold one brand last year. If Outdoor & Action Sports continues to offer the growth and returns it’s getting now, and brands in other segments can’t offer similar ones, I would expect to see further buying and selling of brands by VF.