VF’s Quarter Ended June 30- Good Numbers, China, and Retail Strategy

They had a strong quarter and we’ll get to the numbers.  Oh hell, let’s start with a summary of the numbers.  Revenues were up 7% to $1.577 billion.  Their gross margin reached 47.1% (a record) and net income rose 48.7% to $111.5 million.  The balance sheet is strong to the point where don’t have to worry about analyzing it, though I would note that inventories fell almost ten percent from a year ago.  Lower inventory on higher sales points to good management.

But aside from the numbers, I thought there were three things that were worth discussion.  First, and probably least important, is that there was no mention of Reef.  That really only matters because in our industry we’d like to know what was going on with it.  It’s an awfully small piece of VF.

It’s no secret that Reef has had some difficulties.  You’ll probably recall that shortly after its acquisition by VF, they dropped “the butt” in their advertising and promotion.  I wouldn’t say that was the cause of the problems, but I’d note that when the going got tough, the tough brought back “the butt.”  I, for one, was glad to see it, so to speak.

On a more meaningful note, there was a discussion in the conference call of China and the costs there.  Let me give you a little background.

China has built its economic growth model (very successfully) on cheap labor and exports.  But they know that’s coming to an end and that they have to transition their economy over time to one where growth is driven by domestic consumer demand.  That means more skilled labor input and higher wages.  This is just normal economic development stuff and China would hardly be the first country where it’s happened.

You’re probably aware that there have been some recent and ongoing strikes in China for higher wages.  The government has at some level encouraged or at least tolerated these because they are aware of the economic evolution (described above) that needs to happen.  But at the same time, they want to control this process and when these strikes take place outside of the government union organization, as some have, they get nervous and worry about their control.  This is happening while the Chinese currency is being allowed again to gradually strengthen and after and after the big recession based drop in demand eliminated a lot of capacity which is now missed.

In the conference call, VF management noted that there were pressures from supply and demand imbalances.  As they described it, manufacturing capacity fell dramatically at the economic bottom, and hasn’t caught up with the rebound in demand.  Cotton (which VF obviously cares about) is at an all time high and demand is ahead of supply.  There are labor shortages in quite a few countries, they note.  Freight costs are running higher.  They indicated that only 200,000 shipping containers went into service last year.  In a typical year, it would be around two million.

As a result, they expect product cost increases of a few percentage points next year.  But they point out that less than 25% of their supply comes from China, that they own and operate a third of their manufacturing, and that they have been running factories for a century (well, not the same guys I guess).  That gives them the experience and operating acumen to manage the issues better than others.

The next issue is retail.  At the end of the quarter, VF had 768 stores across its brands.  They are on track to open 80 to 90 this year.  Total direct to consumer revenues increased by 7%, “…driven by new store openings in the quarter.”  If you’ve read what I’ve written about what Billabong, Genesco, and other multi brand companies are doing, you know that the push into retail by brands is only going to continue.  They have the size, the systems and the operating sophistication to be very successful in retail and the extra margin they can earn by putting their own brands into their own stores is just too attractive to pass up.  So the question for small specialty retailers (and maybe some not so small ones eventually) and brands that don’t retail is how do you compete?

Sorry, this isn’t the place to go into that, but you’d better be thinking about it.  I’ve been beating this drum for a while and expect to keep pounding it.

VF noted that Van’s revenues were up 24% in the quarter.  It grew 20% domestically and doubled in Asia.  The domestic growth was 75% from the wholesale business.  The remainder was from opening new stores.  They didn’t give any comparable store numbers.

They noted that the Vans business in China had nearly doubled and the brand was very strong there even though Vans only started there a couple of seasons ago.  Being small makes doubling easy, I’d point out.  They are investing in Vans which they see as a very strong brand.

 Gross margin improved 370 basis points.  A reduction in product cost added 200 basis points, retail performance was responsible for 70, and the rest just came from operating well including clean inventories.  They noted that big increases were easier to get quarter over quarter due to how bad things were last year.

They continue to be focused on making acquisitions and are especially interested in the outdoor and action sports area.  They haven’t made any this year and suggest that it’s because the prices being asked are too high.  They note that they have the ability to make a billion dollar acquisition, but that historically, they have focused on smaller ones.  Look for more deal from them.

The outdoor and action sports segment generated $584 million in revenue during the quarter, or almost 37% of the total.  That’s up 11.6% from the same quarter the previous year.  It is the largest of their six segments by revenue and generated $81.5 million in operating profit.  They said during the conference call that segment is outgrowing other parts of their business and offers higher margins. 

Finally, they noted that there was a note of caution back in people’s voices right now for spring bookings, though they hadn’t seen any meaningful cancellation.  I think we all share the sense that maybe we’re not coming out of this recessions quite as fast as we hoped; not as we expected, but as we hoped.  I for one am not surprised by that, though I am disappointed.  Financially caused recessions suck.