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As described in my goals post here, my focus has changed to only choosing “Quality” companies for my options trades. Chasing premium is nice when it works, but as you will see below, I have been left with some companies that I would rather not own.
Instead, I want to focus on companies with a decent track record and that I am confident will still be viable companies in 5 years. They will be companies that I would not mind holding for a couple of years if things don’t go to plan. Most of the time, these will be dividend-paying companies, but for this strategy, dividends are not a requirement.
I will outline below which companies I am holding for a long time, and hopefully, any new trades I make will now meet my criteria below.
How do I define a Quality Company?
So how do I define a quality company?
They must all have the following characteristics in no particular order
- Stable and growing top Line
- Stable and growing bottom line
- Stable and growing cash flows
- Ability to manage their current debt
- Have a competitive advantage and a reason I believe they can continue growing in the next five years
Last week I Sold to open a CSP on VFC who are one of the world’s largest apparel, footwear companies connecting with a portfolio of iconic outdoor, active and workwear brands.
VCF JAN 20 ’23 42.5 PUT
Is the top line Stable?
Over the past ten years, I would consider the company’s revenue stable. However, there is not a lot of growth, with revenue in 2013 being $11,419 to $11,841 in the 2022 Annual Report. In 2018, the company completed a transition period where it changed its fiscal year end to the Saturday closest to March 31 from the Saturday closest to December 31. This skews the results a little for 2018, and you will notice there is no Annual report for 2018.
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As I am selling puts and not looking to hold this company forever, I am happy to look past the transitional period and compare the remaining years.
Ideally, I would prefer to see a little more growth in the top line, but I am satisfied that it is stable, and the company does have some huge brands such as Vans, Wrangler, NorthFace, and timberland.
Overall, I see no red flags, and I am completely satisfied that the company can reproduce steady revenue over the next couple of years.
What do earnings look like?
Net Income is a little bit choppier than revenue, but when reviewing the income statement, there seems that in 2020 and 2021, charges for the impairment of goodwill and intangible assets and pension settlement was the main reason for the decline in Net income.
The cost of goods sold has also been steadily increasing, including a larger increase in 2022. I would expect this trend to continue in the current environment.
Do they generate consistent free cash flow?
I prefer to see free cash flow growth, even if it’s by a percent or two. However, VFC has been quite static, with FCF growth from $1.2 billion in 2013 to $1.1 Billion in 2021. In 2022 it was even lower at $618 million.
From my analysis, the changes in Free cash flow are attributed to the company’s use of working capital. In companies such as VFC, where they may experience some seasonality in sales, working capital can help smooth out fluctuations in revenue and help the company “pay its bills” while preparing for the busy months.
Except for 2022 and 2020, the company’s free cash flow was comfortable and able to cover dividends over the last ten years. If I were looking at this as a dividend investor, I would be a little concerned about this trend and the potential for a dividend cut, particularly with the threat of a recession which could impact consumer spending.
Can they manage their debt?
Debt is an important metric for VFC dividend safety. Interest coverage is probably one of the most important metrics that I use. The more debt a company has, the greater the amount of interest they have to pay. This can have a huge burden on cash flow, which may affect the cash left over to pay a dividend.
The Interest coverage ratio is calculated as EBIT/Interest Expense. This is essentially the number of times a company can pay its interest with its earnings before interest and taxes. I prefer the number to be above three or above the industry average, but the higher the number, the better.
According to Ready Ratio, VFC has an interest coverage ratio of 4.26, which is above my threshold of 3. However, they are much lower than the industry average of 7.49 very high.
The debt to equity ratio is a common financial leverage ratio that represents the amount of debt and equity that is used to finance a company’s assets. A high percentage of debt in relation to equity is usually a red flag for me.
It is calculated by dividing a firm’s total liabilities by total shareholders’ equity.
Currently, the debt to equity stands at 104%, around the industry average.
Do they have a competitive advantage?
VFC competes with firms such as PVH Corp. (PVH), Fossil (FOSL), and The Gap (GPS), NIKE (NKE) and Adidas (ADS), Under Armour (UA) and Lululemon Athletica (LULU). As you can see there are really some top global names across many different aspects of clothing. However, VFC’s diverse yet focused portfolio of brands can compete with these names. Owning several premium brands offer pricing power which has helped the company through many recessions. Brands such as Wranglers, Vans and North face have been around or decades and so far the company has proved it can move with the times and keep their brands relevant.
Fears of a recession and current inflation rates are a huge risk to the company over the next 5 years and in truth we don’t know how ling or how much of an impact this will have. However, if we look to the past, the company has shown shown recessionary resilience and also have an amazing divided growth record.
(BTW my buddy Tiago has a ice article on his sub stack about PVH Corp That I recommend reading https://tiagodias.substack.com/p/pvh-corp
Conclusion
VFC have some red flags particularly if I was buying them purely as a dividend growth investor. While they have an amazing record, the trend in free cash flow not covering its dividend would concern me. However, the company has a strong portfolio, Steady revenues and has shown strong recessionary resilience. The company is down from $99 in the beginning of 2020 to around $41 dollars today. I opened the trade when they were trading at around $47 but as it stands it looks likely I will be assigned these shares. I would be happy to hold this company in my portfolio and collect a 4% dividend yield while I call to see covered calls if the price recovers.
Other open Positions
CCL SEPT 16 ’22 17.5 PUT.
This is one that I have held for over a year and I keep rolling it out. It is getting quiet close to the assignment date so I will look to roll this out again. Originally this was a play on the world opening up after Covid and people going back traveling and going on cruises again. This hasn’t worked out as I planned, however I will give them until the end of the next summer to see if things start to turn around enough for the share price to improve.
WISH DEC 16 ’22 3.5 CALL
This one I have held for over a year as well and was one of the first companies that I fell for the juicy premiums. I am selling cover calls on these and have reduced my breakeven point from over $7 to just over $3. I will continue to sell covered calls at my breakeven point until I am assigned and I can get rid of these guys for good. They are a painful and good reminded why I should stick to companies that at least have some sort of decent track record.
VTRS JAN 20′ 23 15 CALL
I currently own 200 shares on the company at an average price of $12. While I am happy to keep hold of the company, I don’t think their share price will move too much over the next couple of years as they have sold the most profitable part of their business. I would be happy to sell them for a nice profit and equally I am happy to hold them, collect a 4% dividend yield and collect some premiums on top
BAS NOV 18′ 22 35 PUT
I already own 10 shares of BASF which I bought at €50 and I personally think that if I could buy more at €35 that it would be a bargain. I wont say to much more as I analyse this company as part of my work for Sure Dividend But I am sure you can guess that I am bullish on them over the next 5 years.
Conclusion
At the moment I have 5 open positions with an average yield of 4.74%. 5 positions is the most positions that I am comfortable with and any one time and I don’t want to inhibit too much cash in my portfolio especially when we have a market that is potentially offering us some long term bargains.
I would also love to hear if you of you guys are still selling puts and what companies are you currently using.
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