Description

Kontoor Brands is a denim apparel company spun off from VF Corporation in ’19 which operates mainly through the Wrangler (~64% of revenue) and Lee (33% of revenue) brands. KTB is uniquely vulnerable to weak end markets as ~68% of revenue comes from US wholesale (WMT, TGT and department stores) and they have posted revenue declines for the past 5 years. Not only they over-index structurally challenged brick and mortar, but their main customers have also been increasingly proactive in emphasizing their own brands at the expense of third parties. KTB will have a tough time offsetting these dynamics as their less developed international and DTC operations mean they also under-index the higher growth markets for denim:

Kontoor is comprised of:

o   Wrangler (64% of revenues): mass market American brand founded 70 years ago and rooted in western apparel.

• Wrangler is mainly US focused (~88% of revenues are based in the US)
• ~81% of segment sales are to US wholesale channel (ie WMT/TGT/dept stores)
• ~10% of segment sales to non-US wholesale
• ~10% through DTC

o   Lee (33% of revenues): Founded 130 years ago and positioned as a casual/stylish denim brand

• Lee is relatively more int’l focused (~30% of revenue)
• ~40% of revenue through US wholesale
• ~30% of revenue through int’l wholesale
• ~30% DTC

          o     Other segment includes Rock & Republic brand as well as VF Outlet (the latter of which is being eliminated)

• Majority of business (~2/3 of total) is concentrated in high-risk US wholesale (+35% of revenue to WMT, HSD from TGT and most of the remainder from department stores)

             o   WMT (+35% of revenue) and TGT (~5-10% of revenue) have been moving more actively to promote their own private brands across apparel which represents new/advantaged competition in their stores.

• This has led to KTB revenues from WMT declining at a LSD CAGR for past several years 
• WMT own brand already has ~10% share in mens denim vs Wrangler ~8% (and Wrangler obviously has broader distribution since they’re not WMT exclusive) Similarly TGT has ~10% share in womens denim v Lee ~3%.
  • Importantly, WMT also recently promoted a new head of apparel who has a background in expanding private brand penetration in their higher end lines-reinforcing that strategy in denim is an obvious next step.
  • The math on their business with WMT implies they did ~$858MM in revenue with WMT in '18, $857MM in '19 and $797MM in '20 so they already appear to have inflected negatively with their largest customer.
• Looking at  HBI who also had significant exposure to WMT/TGT, when those customers started shifting towards more private label innerwear, the Co saw revenue growth decelerate and EBITDA to decline at LSD CAGR over 3 years (stock cut in half over that period)
• Much of the remainder of the wholesale business relies on Department Stores so it’s not like the non-WMT/TGT portion is a picture of health
• KTB brands have been losing share in the US

• The Co has tried to reposition themselves towards DTC and this is proceeding, but branded DTC still <15% of revenue and it’s not clear their brands have the resonance to drive DTC

o   Levi’s close to 40% of sales from DTC. LEVI's not only has a strong e-commerce DTC offering, but they also have +1K of their own stores vs virtually nil for KTB. This not only gives LEVIs a better/closer relationship with the customer but also gives them a more viable platform to sell products other than denim (ie it's easier to sell tops in your own stores rather than a WMT where your tops are competing against other manufacturers)

o   This makes sense in the context of KTB’s brands low unaided awareness v Levi’s (or other brands with strong DTC presence)

o   KTB’s DTC also skews towards traditional retail rather than higher margin online sales (e-commerce sales <3% of total/~20% of DTC)

o   This will also be made harder by the fact they underspend on marketing (They spent ~$120MM on advertising pre-COVID v ~$400MM by LEVI)

• The Co will also face rising costs from cotton which is especially problematic for a value oriented brand. We don’t know exact sensitivity to cotton pricing, but cotton is their largest commodity input and pricing is up 30% over past 6 months.
  o The risk posed by this is exacerbated by the fact they have reduced inventory 26% YoY while they’re also expected a post COVID bounceback in revenue  
• 

Risks/mitigants:

• The Company has embarked on a two phase cost cutting plan post VFC spinoff. Phase 1 (called Horizon 1) was focused on structure and cost optimization. That is largely complete and the next phase (Horizon 2) will be announced at a May 24 analyst day. This plan will be more balanced bw growth/cost cuts and it's possible the market responds positively to the news. This could argue for a patient approach to establishing a short and waiting until post Horizon 2.
  
  • It's worth noting that post spin, mgmt has emhpasized the dividend (target 60% payout ratio) and a TSR target of ~5% dividend, 2-3% margin expansion and 1-2% revenue growth. So I wouldn't expect them to reorient around an aggressively growth oriented plan.
  • Additionally, note that once COVID began, the Co cut their quarterly dividend from $0.56 to $0.40 to conserve cash. Now that the worst of COVID is behind us, they could look to raise the dividend again which could be another upward catalyst for the stock.
• The Company says they gained 200 bps of share in Q420. This seems almost implausibly large, but if it's true then perhaps a step change has happened in demand.
• They may have an opportunity to increase exposure in international markets. Lee, in particular, has a strong foothold in China and may continue to benefit from that exposure. Wrangler is being introduced in China and while it's too soon to tell what kind of resonance it will have, it's possible they can pivot towards more international led growth.
• LEVI and KTB have both flagged the potential for a new denim fashion cycle. This is worth monitoring.

Catalyst

Poor channel exposure reasserting itself