2023-08-22 08:29:56 ET
Summary
- Kontoor Brands reported Q2 earnings that beat consensus expectations.
- The poor performance of the Lee brand in the U.S. has pressured growth.
- We expect shares to remain volatile with the market focusing on what remains a weak growth outlook.
Kontoor Brands ( KTB ) manages the brand portfolio for "Wrangler" and "Lee", specializing in denim and outdoor lifestyle apparel. Following a difficult 2022 defined by inflationary cost pressures and supply chain disruptions, the company has moved forward by taking restructuring actions to focus on its strengths to drive financial efficiencies. KTB stock has rallied about 20% this year, benefiting from the improved market sentiment amid resilient economic conditions.
That being said, the challenge here continues to be soft top-line growth with some weakness in the Lee brand segment. While the company is fundamentally sound and offers a compelling 4% dividend yield, we believe the upside in the stock may be limited from here until there is clearer evidence of a stronger sales rebound.
KTB Q2 Earnings Recap
KTB reported Q2 non-GAAP EPS of $0.77, beating the market estimate by $0.14, but down from $1.09 in the period last year. Revenue of $616 million was flat compared to Q2 2022 but also came in above consensus. The stock surged on the report, climbing by more than 15% on the day, which we connect to what may have been low expectations.
Globally, the direct-to-consumer business has been a strong point , with sales up 14.4% y/y, helping to partially balance a -3% decline in the larger U.S. wholesale group that represents nearly three-quarters of total revenues. Indeed, that weakness in the core U.S. market was pulled lower by a -15% decline in sales from the Lee brand group where the seasonal assortment was cited as performing poorly.
Taking a deeper dive into the numbers, there are several mixed signals. The gross margin at 41.0% declined by 250 basis points from 43.5% in Q2 2022. Management noted some quarterly volatility in the metric based on the timing of certain inventory actions along with the impact of implementing a new ERP software system.
There is an expectation for some improvement going forward, although the figure remains well below levels from 2021 when the gross margin reached as high as 46%.
From the earnings conference call , management is taking an overall cautious outlook citing "challenging U.S. macro conditions" but sees room for financial trends to benefit from easier comparables against specific headwinds in Q4 2022.
Kontoor is targeting full-year revenue growth in the "low single digits". The adjusted EPS guidance is between $4.55 and $4.75, if confirmed, represents an increase of 3% compared to the $4.49 result in 2022.
Finally, we note that the company ended there quarter with $82 million in cash against approximately $850 million in total debt. Considering around $350 million in EBITDA over the last twelve months, we view the net debt to EBITDA leverage ratio of around 2x as stable.
What Do We Think of KTB?
We know that the appeal industry and broader retailers have struggled this year with growth, but it becomes a question of when and how Kontoor will be able to revitalize the brand's momentum at a time when wholesalers are pushing back on new inventory orders and consumers are tightening their belt.
According to consensus estimates, the market sees revenue growth averaging less than 2% per year through 2025. On the earnings side, the forecast is for a rebound in EPS net year towards $5.00 as margins normalize, but remain flat from that point into 2025.
In terms of valuation, KTB is trading at a forward P/E of 11x or 10x based on the 2024 consensus EPS. Our insight is that the stock doesn't necessarily stand out next to segment peers like Levi Strauss & Co. ( LEVI ), V.F. Corp. ( VFC ), or Buckle Inc. ( BKE ) trading at similar multiples.
That analysis extends to the stock's current dividend yield of 3.9%, which is in the range of BKE at 3.7%, but below a stock like The Gap ( GPS ) that offers a higher yield of 5.8%. Here we can bring up what may be a structural weakness of KTB being its relative concentration within "denim" and the outdoor lifestyle segment while peers benefit from a more diversified exposure to wider apparel segments.
KTB Stock Price Forecast
We haven't seen enough to get excited about shares of KTB. The company looks "fine", but that's typically not a very good investment thesis or a strong reason to turn bullish on the stock.
We rate KTB as a hold with a price target for the year ahead at $50.00 suggesting shares are currently near fair value. Naturally, the bullish case for the stock is that there is an upside to current consensus estimates over there next few years, although we'd say that risks are more likely tilted to the downside.
Weaker-than-expected results in the upcoming quarter along with a scenario where macro conditions deteriorate could open the door for a deeper correction. Monitoring points for the rest of the year include the evolution of the gross margin and cash flow trends.
For further details see:
Kontoor Brands Stock: Weak Growth Keeps Us On The Sidelines