Go back a couple of months and look at the top holdings in the PowerShares Dynamic Consumer Discretionary Sector ETF (NYSE:PEZ). One of the biggest was Ralph Lauren (NYSE:RL), the ninth-largest holding at 2.62% of the overall portfolio. Flash forward to Dec. 7, and it’s nowhere to be found. Interestingly, V.F. Corp. (NYSE:VFC), Ralph Lauren’s biggest rival, has taken its place in the top 10 holdings.
While I generally like Ralph Lauren’s business, I think the ETF has the right idea. Although VFC is up 64% year-to-date, it still makes sense to buy into its stock. If you can own just one, V.F. is the better choice. Here’s why.
Diversification
When you think of Ralph Lauren the brand, it’s impossible to do so without thinking about Ralph Lauren the man. He’s iconic in the world of American fashion. But what happens when Ralph is gone? Sure, he’s built an organization befitting one of the world’s most successful apparel companies, but his fingerprints are all over the business that bears his name. Once Ralph Lauren is gone, there will be less attachment to the brand, making it difficult to keep growing. Adding brands like Rugby and Club Monaco are reasonable attempts to diversify away from its founder, but at the end of the day, it always will be about Ralph Lauren.
V.F., on the other hand, is no one person or business. If CEO Eric Wiseman leaves tomorrow, the effect should be negligible because its five segments each have a group president overseeing several of the 25 brands it owns. None, with the exception of John Varvatos, has any connection to an individual person. In this way, VFC is very similar to Berkshire Hathaway (NYSE:BRK.B), which is heavily tethered to Warren Buffett, but few of the companies it owns have strong associations to one person.
Latest Quarter
September was the end of the second quarter for Ralph Lauren and the third quarter for V.F. With similar businesses, it’s safe to compare quarters despite the difference in year-end. Ralph Lauren grew revenues 24% in the quarter to $1 .9 billion, while V.F. grew revenues 23% to $2.75 billion, which includes $163.6 million in sales from the acquisition of Timberland. Without those sales, revenues grew 16%.
The benefits from the acquisition were immediately accretive. VFC expects full-year adjusted earnings per share of $8.15, including $0.55 from Timberland. Ralph Lauren hasn’t provided an outlook for 2012. Analysts estimate earnings will be $6.99 per share, or 22% higher year-over-year. VF’s will be 27% higher with Timberland’s contribution, and 18% without.
V.F. paid $2.3 billion, or 1.6 times sales, for Timberland. A great price when you consider you would have to pay a much higher multiple for either VFC or Ralph Lauren. Not to mention the acquisition simultaneously strengthens both its outdoor brands and international business. In the short term, V.F. gets a boost to revenue and earnings. In the long term, it makes VFC a better company, as Timberland is one of the premier outdoor brands anywhere.
Returning Cash to Shareholders
Capital allocation is where great businesses shine. In November, V.F. increased its quarterly dividend by 14% to 72 cents per share, meaning the company has raised its dividend for 39 consecutive years. At current prices, VFC’s dividend yield is 2.1%, four times Ralph Lauren’s. In its latest fiscal year, V.F. repurchased 5.1 million shares at an average price of $81.11. That’s a 66.6% return on its investment based on a Dec. 8 share price of $135.09. Ralph Lauren repurchased 6.2 million shares in fiscal 2011 at an average price of $95.90 for an ROI of 52.6%.
Both companies do a good job repurchasing shares. However, when you consider that Ralph Lauren pays a much lower dividend than V.F., makes very few acquisitions (Club Monaco was an exception) and possesses little debt, it can’t be considered a better allocator of capital than VFC. It’s a good operator for sure, but the allocation of capital is another skill entirely. When Ralph Lauren is gone, will it still be able to operate as effectively? I’m not so sure.
Bottom Line
While I like both businesses, V.F.’s business model is more sustainable in the long term. For this reason, I believe VFC is the better choice.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.
