Summary
- Kontoor Brands' share price has risen by 20% after its results released earlier today exceeded expectations for both 2022 and Q4 2022.
- The company's operating margin is strong, too, and its EPS has also increased. It also expects positive growth and a further EPS rise in 2023.
- With an attractive P/E, both TTM and forward, it appears that Kontoor Brands is set for a further increase in price. On this basis, I am upgrading the stock to buy.
Kontoor Brands, Inc. ( KTB ) is on a roll. After languishing for years, 2022 has seen it getting in fitter financial health. Its Q4 2022 results released earlier today have made investors so happy that its share price is up by, wait for this, 20% as I write. And the day is not done yet. This has resulted in an increase of 32% in price year-to-date (YTD), which is far higher than many consumer stocks I have covered recently. Here, I take a closer look at Kontoor's numbers in some detail to figure out what it means for its share price going forward.
Revenue rises more than expected
The highlight for me is Kontoor Brands, Inc.'s revenue increase. When I last wrote about Kontoor Brands, which owns well-known denim brands like Wrangler and Lee, in November last year, it had projected a full-year revenue increase of 4%. Instead, Kontoor has reported growth of 6.3%. But that is not all. The real surprise is in its numbers for the final quarter of the year (Q4 2022). Its projections indicated a drop of around 1% year-on-year (YoY) in revenues. Instead, it has seen a 7% increase!
It is one thing to see a revenue surprise, it is quite another to see a revenue surprise at a time of sustained macroeconomic weakness. And indeed, signs of weakness are visible, as the company reported a decline in international revenues of 8% for the full year, predominantly because of the drag from COVID-19-related lockdowns in China. But demand also dropped in Europe.
So, what has driven this latest jump? Because of the U.S. market. Revenue from that market increased by 11% during the year, driven predominantly by growth in its wholesale segment.
Healthy operating margin
Kontoor Brands, Inc.'s operating margin has also risen to 13.6% in 2022, an over-2 percentage point increase from 2021. The improvement over the past year is notable, going by the fact that 2022 was a year of high inflation. That said, looked at another way, the picture is a bit more mixed on the margins. First, it fell slightly compared to the first nine months of the year, when it was at 14.1%. The company also reports a fall in adjusted operating margin to 14.1%, a drop of 10 basis points from the last year. The fact that it talks about the adjusted margin reflects positively on the company's transparency to my mind, though, especially at a time when its reported margin has actually increased.
Kontoor Brands ascribes the decline in adjusted operating margin, as expected, to inflationary pressures "on input costs and inventory provisions." It also, however, points out that it has implemented "expense controls, lower compensation costs and strategic pricing," which reflects efforts at managing inflation. As inflation comes increasingly under control, as is widely forecast, the company's margins can look even better going forward.
EPS increase
The company's earnings per share ((EPS)) have also risen in 2022. The reported diluted EPS is at $4.31, an increase of 30.2% over 2021, while adjusted diluted EPS is at $4.49, an increase of 4.9% YoY. The higher adjusted EPS is because of lower adjusted operating expenses, resulting in a higher adjusted income. However, the lower growth level than that for reported EPS is also because of these very operating expenses. It is a base effect, essentially, as last year's adjusted expenses were significantly lower than on a reported basis (see table above).
Outlook and market multiples
With the latest EPS numbers, even after the massive increase in share price today, Kontoor Brands, Inc.'s GAAP P/E is at 12.2x and the adjusted P/E is at 11.7x after the company's results. These are lower figures than those for the consumer discretionary sector at 15.1x and 14.5x, respectively. If the company was expected to underperform in 2023, I could understand why its P/E is lower than the sector average.
However, going by its 2023 outlook, that is not the case, either. It expects revenue to grow in the low-single-digit. This is less than the growth seen in 2022, but do recall that it had expected just 4% growth in revenues this year as well. That does not automatically mean that it will see a revenue surprise this year, of course.
2023 is expected to have its own challenges. The U.S. economy is expected to slow down , and the company acknowledges as much in its outlook. This means that it expects to grow despite taking into account the macro weakening in the U.S. This, in itself, is worth underlining in my view. If it does indeed happen, it would be the third consecutive year of growth. Between 2017 and 2020, the company saw a contraction in revenues every single year.
Along with revenue growth, Kontoor Brands also expects an increase in EPS to between USD 4.55 and USD 4.75. Assuming it comes in at the average of this range, it yields a forward P/E of 11.6x, which is also lower than the 14.9x for the consumer discretionary sector. This along with the current P/E ratios indicates more upside to Kontoor Brands, Inc. stock.
I reckon that there could be some 20% upside to Kontoor for now. This is not as farfetched as it sounds right now. In April 2022, the company was trading at levels higher than those suggested by this increase. Admittedly, those were the highest-ever levels seen, but then we are also talking about improvements in both revenues and earnings since.
What next?
I do believe, however, that there are still risks to the company. The macroeconomic situation is still challenged. While growth is expected in the U.S., there is also talk of a potential recession. So we cannot take its growth projections for granted. This is especially so given its weak past performance. Further, inflation is still relatively high. While it can come off, as is predicted, any shock to the system can send it spiraling upwards again. Going by Kontoor Brands' healthy operating margins, it clearly has the pricing power to pass costs on. But at the same time, demand can be impacted.
For now, though, things are going well for Kontoor Brands, Inc. Its better-than-expected revenue growth, good margins, EPS increase, and attractive P/E ratio indicate more price rise is due. However, I would watch the broader macro picture as well as its own results just as an exercise in caution. For now, I am going with a Buy rating on Kontoor Brands, Inc.
For further details see:
Kontoor Brands: A Buy On Better-Than-Expected Results (Rating Upgrade)