2023-05-17 23:32:40 ET
Summary
- Kontoor Brands ended 2022 on a high with solid results and a positive outlook for 2023; however, Q1 2023 has been disappointing, missing revenue and EPS expectations.
- US brand growth is progressing, but sales in China decreased by 34% YoY.
- Cautious of maintaining FY 2023 forecast amidst challenging macroeconomic environment.
Kontoor Brands, Inc. ( KTB ) is a small-cap stock of $2.25 billion, standing its ground in the competitive apparel and accessories industry. While the stock has lost its momentum after a strong Q4 2022 followed by a disappointing Q1 2023 Earnings Report . Over the last three years, KTB stock has delivered more generous price returns than its peers Levi ( LEVI ), Guess' ( GES ) and previous parent company V.F. Corporation ( VFC ), with returns of 149.90%.
Price return over three years versus peers (SeekingAlpha.com)
Although the company fell short of its earnings and revenue projections in the Q1 2023 Earnings report, the management remains optimistic about the Chinese market's speedy recovery. However, the business's international wholesale performance has had a detrimental effect this quarter. Consequently, I suggest a hold rating until we see improvements in the Chinese market, while remaining mindful of the macroeconomic challenges and the potential adverse effects on the US market.
Introduction
Kontoor Brands spun off from V.F. Corporation in 2019 with a focus on denim. Today the company aims for its customers to express themselves through a wider variety of clothing choices freely. With its roots set in denim management has expanded categories to focus on casualisation, comfort and outdoor activities. It generates revenue from two segments, namely its Wrangler and Lee brands, including denim, apparel, footwear and accessories. The company is present in the USA, international and direct-to-consumer markets. Below we can see the company's revenue broken down into regions and brands, with Wrangler in the US as the most significant contributor to its top-line growth.
Segment overview Q1 2023 vs Q1 2022 (sec.gov)
A diversified business strategy impacts the company. At the same time, we can see that the US revenue was up 2% to $518 million, and international sales dropped by 14% to $149 million due to a 32% decrease in China sales YoY connected to the COVID policy changes in China impacting Lee's China wholesale business.
However, in the year's second half, the company expects positive growth results from its international markets due to China recovering at a quicker-than-forecasted rate. On the other hand, macroeconomic factors in the US are expected to slow down consumer demand in the USA. For this reason, the management has maintained its double-digit growth forecast for FY2023, with expectations of revenue increasing by 13 to 14%, adjusted EBITDA rising between 17% and 18% range, and adjusted net income increase between 30% and 33% range.
Q1 2023 Earnings Highlights
We can see that although Kontoor Brands missed its EPS expectations by $0.04 to reach $1.16 per share, it has a long quarterly history of consistently beating predictions. We can also see that EPS and revenue results were lower than one year prior. In Q1 2023 Kontoor Brands saw revenue fall by 2% YoY to $667 million, caused by poor performance of the international wholesale business, primarily driven by the continued impacts of COVID-policy changes in China.
Gross margin also decreased this quarter to 43.0% of sales due to higher inflationary pressures on input costs and the geographic mix impacting performance impacted by production downtime in China. If we compare Kontoor to its peers, we can see that its gross margin is significantly lower, which is concerning in a competitive environment where inflation continues to increase costs.
Kontoor Brands has been consistently generating positive free cash flow over the last five years, but currently has a negative levered free cash flow of $82 million. The company has a program for dividend and share repurchase, with $62 million still remaining in the share repurchase program. Its dividend payout ratio is high at 44.34%, which is almost half of its earnings. The next Ex-Div rate is on June 8, and it has a FWD yield of 4.78%.
After examining the company's balance sheet and comparing it with its peers, it is evident that it holds a lower amount of long-term debt, approximately $800 million. As of Q1 2023, the company has $53.68 million in cash, $50 million in outstanding borrowings, and $438 million available for borrowing under the credit facility.
Debt information (sec.gov)
Valuation
Currently, the stock is trading lower than its average target price of $51.71. This is due to a decrease in bullishness among analysts, as evidenced by Barclays analyst lowering their price estimate to $45 after the Q1 2023 Earnings results. These results were affected by ongoing economic challenges and weak international performance. Over the past three and six months, the stock has underperformed the S&P index. However, it has an attractive price to earnings ratio of 8.97, which is below the median for the consumer discretionary sector and below peers Levi and V.F. Corporation. We advise caution due to a reduction in gross profit margin, which is lower than its direct competitors, and weak growth. Nonetheless, the company is maintaining double-digit revenue growth for FY2023.
Quant Rating (SeekingAlpha.com)
Risks
Kontoor Brands is a stock in the consumer discretionary sector that is sensitive to market conditions. If the economy experiences a downturn, it could greatly affect the company's performance as consumers become more cautious with their spending. Additionally, the business's success largely depends on growth in the Chinese market, which is currently in recovery mode. Due to ongoing uncertainty in the global economy, there is a risk that a slowdown could have a negative impact on the company as a whole.
Final thoughts
Kontoor Brands experienced a decline in market confidence following a weak Q1 2023 performance, resulting from a drop in sales in its China market and failing to meet EPS and revenue expectations. Nonetheless, the management team maintains that FY2023 will see double-digit top-line growth due to a faster-than-expected recovery in the Chinese market. Additionally, there is a growing trend towards direct-to-consumer sales, which yields healthier profit margins. However, given potential negative impacts on the US and international markets due to economic concerns, it may be prudent to wait and see how the second half of the year unfolds. Therefore, I recommend a hold rating.
For further details see:
Kontoor Brands: Will International Wholesale Provide Double-Digit Top Line Growth?