The Right Stock at the Right Time

04/21/2009 1:00 pm EST


James Stack

President, Stack Financial Management

James Stack, editor of InvesTech Research, finds a stock that should do well in a cyclical rebound but provides a “margin of safety” if the economy and markets turn down again.

Historically, as bear markets run their course, cyclical stocks are among the first to rebound after the market bottom. Of course, we cannot yet say with certainty that the bear market low is in place. As such, it becomes even more important that we search for discretionary stocks that not only have up side potential but that we are comfortable owning even if this market once again falters.

VF (NYSE: VFC) is the world’s largest publicly held apparel manufacturer and distributor. The firm owns an incredibly diverse line of brands, including such well-known names as Wrangler, Lee, North Face, Vans, and Nautica. It markets these products through various channels, including chain stores, specialty stores, and company-owned retail outlets. VFC also has an international presence with 30% of 2008 sales coming from outside the US.

The company [owns] a portfolio of brands divided into two key segments: lifestyle and heritage. With its heritage brands (Wrangler and Lee) serving as cash flow generators and adding stability to earnings, VFC has the freedom to pursue growth in its key outdoor lifestyle businesses (Reef, North Face, etc.).

While many other apparel manufacturers are putting growth on hold, VFC is continuing to add company-owned stores, which sell only VFC products and provide diversification to the traditional chain retail outlets, as well as higher margins (i.e., a better bottom line).

Despite occupying a sector that, by definition, cycles with the market, VFC maintains a healthy balance sheet with manageable debt and consistent cash balances. Also, VFC throws off enough free cash flow annually to repurchase roughly 8% of outstanding stock at current prices. [So,] even without any growth in revenues, VFC should be able to earn a return of 8% by standing still (assuming management deploys cash prudently). In our minds, that is a great start!

Of course, we do expect earnings growth, both organic and through acquisitions, from VFC. Management is targeting long-term earnings per share growth of 10% to 11% per year. Currently, the company is paying a $2.36 per share annual dividend—equivalent to a yield of 3.6%. This yield amazingly approaches the yield of the 30-year Treasury bond (3.7%). VFC’s longstanding commitment to shareholders is evidenced by the 12.2% annualized dividend growth rate over the past 35 years.

We also view current valuation levels as an attractive entry point. All of the major multipliers are sitting at levels not seen since the end of the 2000-2002 bear market. During the bull market period that followed (2002- 2007), VFC outperformed the S&P 500 by over 70% (or equivalently, 6.7% per year). Although past performance is no guarantee of future results, we take a positive view of VFC’s risk/reward profile, which is why we have added it as a Buy recommendation. (It closed below $64 Monday—Editor.)

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