2024-01-14 20:58:15 ET
Summary
- Kontoor Brands, a clothing company spun off from V.F. Corporation, has performed well since its spin-off.
- The company has improved profitability well from 2020 forward with positive growth after a poor 2016-2020 revenue performance.
- The revenues should still be looked at closely in the future, as recent growth is largely due to a recovery from pandemic figures.
- The stock is priced for a stable financial future with very minimal growth, suggesting very small upside to my baseline scenario.
Kontoor Brands ( KTB ) produces and sells clothing products. The company was spun off from V.F. Corporation ( VFC ) in 2019. The spin-off seems to have been made due to differing offerings, but also as Kontoor’s gross margins and revenue growth were underperforming when compared to V.F. Corporation’s remaining brands. Kontoor is focused on denim products but also manufactures other clothing products including footwear, other apparel, and accessories under the Wrangler and Lee brands.
Since the spin-off, Kontoor’s stock has performed reasonably well. The stock has appreciated by around 44% at the time of writing from the initial trading price. In addition, Kontoor pays out a dividend with a current yield of 3.44% .
A Good Post-Spinoff Performance
After the spin-off, Kontoor has had a reasonably good performance. In 2019, Kontoor only had an EBIT margin of 8.8% after a series of annual margin decreases but has since been able to improve profitability very well. In the post-pandemic environment, Kontoor’s EBIT margin has reached 12.6% with current trailing figures despite pressured consumer spending.
Kontoor communicated the macroeconomic backdrop to be challenging in the Q3 earnings call and expects the economy to worsen for the company in Q4. As a comparison, V.F. Corporation’s revenues decreased by -1.5% in the quarter corresponding to Kontoor’s Q3, whereas Kontoor was able to grow revenues by 7.9%. Margins have been slightly lower in 2023 for Kontoor than in 2022, but the decrease isn’t very significant; I would attribute the lower margins in 2023 to macroeconomic pressure and expect the current EBIT margin of 12.6% to be sustainable and even have some pressure upwards as consumer spending eventually recovers.
In Kontoor’s 2021 Investor Day Presentation , the company communicated a more focused approach to the operations post-spinoff. Kontoor identified growing U.S. wholesale revenues, growth in China, category expansion more beyond denim, and digital growth as channels for improved performance. Investors can now judge Kontoor’s investor day goals’ success – the company outlined 2023 financial targets, including a revenue target of $2.7 billion, a gross margin of 46.0%+, an operating margin of 15.0%+, and an EPS of $5.00+. The actual 2023 figures & Q4 guidance haven’t quite met the set targets – revenues are guided to be around $2.66 billion, very slightly below the outlined target. On the other hand, profitability measures have had a greater miss, as Kontoor expects a gross margin of 42.5% for the year and an adjusted EPS of $4.50 when excluding a duty charge.
The company expects the gross margin to scale significantly in 2024 due to a better margin mix and lower input costs; the profitability targets could be better met in 2024. I believe that the current pressure on consumer spending is a large factor in the missed targets, so the 2024 earnings are likely to be a more appropriate point of judgment in terms of the targets’ success.
Kontoor recently announced a new share repurchase program of $300 million in December, representing 9.2% of Kontoor’s currently outstanding shares. The repurchase program adds to my confidence in Kontoor’s improved operations’ sustainability.
Long-Term Revenue Trajectory Still Haunts Investors
Although improvements in operations have clearly been made, investors shouldn’t forget about Kontoor’s past performance – as demand for denim products isn’t growing fast, Kontoor’s long-term revenue trajectory is still poor despite good growth from 2020. From 2016, revenues have still had a negative CAGR of -1.4%, and revenues are 4.7% above the 2019 pre-pandemic level with almost four years in between with a high level of inflation. The pandemic-pressured sales in 2020 have been the largest contributor to recent years’ good year-over-year growth.
In 2024, I suggest keeping a close eye on the revenue performance. As consumer spending eventually begins to improve, Kontoor should see good positive growth figures. Decreasing revenues could well imply a fallback to the pre-pandemic performance of constant revenue declines, creating unhealthy long-term financial prospects.
Fair Valuation
Currently, Kontoor’s stock trades at a forward P/E multiple of 11.5. The multiple is above the stock’s all-time average of 10.7, but only in a minor fashion. Overall, the P/E multiple seems reasonable and is in line with V.F. Corporation’s forward P/E of 11.3.
To estimate a fair value for the stock, I constructed a discounted cash flow model. In the DCF model, I factor in very minimal growth, as Kontoor’s long-term history still isn’t great. After a 2023 growth of 1% in line with the current guidance, I estimate a growth of 2.5% in 2024 due to a demand in recovery. Afterward, I estimate the growth to slow down in steps into a sustained growth rate of 1.5%. For the margins, I estimate leverage in 2024 from elevated gross margins. Significant gross margin leverage was mentioned as the management’s current expectation for the year. As a result, I estimate Kontoor’s EBIT margin to rise from 13.2% in 2023 to 14.2% in 2024. Afterward, I estimate the EBIT margin to stay stable. Kontoor’s needs for investments are quite low, and the company has an overall good cash flow conversion.
With the mentioned estimates along with a cost of capital of 8.71%, the DCF model estimates Kontoor’s fair value at $63.87, around 10% above the stock price at the time of writing. The market has slight doubts about a stable performance that I estimate in the model as a baseline scenario, but not significant enough to justify a buy rating in my opinion.
The used weighted average cost of capital is derived from a capital asset pricing model:
CAPM (Author's Calculation)
In Q3, Kontoor had $10.5 million in interest expenses. With the company’s current amount of interest-bearing debt, Kontoor’s annualized interest rate comes up to 5.32%, a relatively healthy interest rate in the current rate environment. Kontoor uses debt moderately; I estimate a fair long-term debt-to-equity ratio of 20%. For the risk-free rate on the cost of equity side, I use the United States’ 10-year bond yield of 3.98% . The equity risk premium of 4.60 % is Professor Aswath Damodaran’s latest estimate for the United States, made on the 5 th of January. Yahoo Finance estimates Kontoor’s beta at a figure of 1.18 . Finally, I add a small liquidity premium of 0.25%, crafting a cost of equity of 9.66% and a WACC of 8.71%.
Takeaway
Kontoor has clearly made operational improvements after the spin-off from V.F. Corporation. The company has achieved higher margins than prior to the pandemic, even though the current consumer sentiment is quite poor. Revenues have also started to grow from 2020 lows after the performance was negative from 2016 to the pandemic year. I still question the growth’s sustainability and suggest to keep a close eye on the revenue trajectory going forward. The stock has some undervaluation in my baseline financial scenario, but the upside isn’t significant enough for a buy rating – for the time being, I have a hold rating for the stock.
For further details see:
Kontoor Brands: Sustainable Post-Spinoff Improvements Are Showing