One of the most popular TV shows in America is "Yellowstone," the dramatic story of a Montana ranch family in modern day times. This legion of fans have purchased show merchandise in droves and dream of living that lifestyle. But If you have ever wanted to dress just like Rip Wheeler or Kayce Dutton, the legendary clothing brand Wrangler has partnered with Paramount Global (PARA, Financial) for an official licensed Wrangler Yellowstone Collection inspired by the hit show.
Wrangler jeans is the flagship brand for Kontoor Brands Inc. (KTB, Financial), which was spun off from VF Corp. (VFC, Financial) in 2019. The company also produces other popular apparel brands such as Lee and Rock & Republic. It also operates the VF Outlet chain of factory outlet stores.
It operates 79 retail stores across the Americas, Europe, the Middle East, Africa and the Asia-Pacific regions. Incorporated in 2018, the company headquartered in Greensboro, North Carolina has a market capitalization of $2.3 billion and is expected to generate $2.6 billion in revenue this year.
Strategic vision
The vision for the spinoff in 2019 was for Kontoor Brands to become a slow growth, high-yielding company that generates substantial amounts of cash flow. However, management felt they could take actions to accelerate growth from recent levels. This involved focusing the U.S. wholesale business with customers such as Kohl’s (KSS, Financial), Walmart (WMT, Financial), Target (TGT, Financial) and Boot Barn (BOOT, Financial).
The next plan was category extension, which means moving beyond just blue jeans into shirts, outdoor apparel and work apparel. Geographic expansion is also expected to be a driver with a focus on China. Lastly, digital expansion is also expected to be a priority, which involves not only e-commerce, but also mobile applications and social media marketing.
Financial review
On Nov. 3, the company reported third-quarter results which were difficult and similar to many other apparel companies operating today. Revenue decreased 5% on a constant currency basis to $607 million, which was primarily driven by significant U.S. retailer inventory rebalancing actions during the quarter and the ongoing impacts of lockdowns in China.
The gross margin was 43.5%, a decrease of 90 basis points on a reported basis and 60 basis points on an adjusted basis compared to the prior-year period. The decrease was due to higher inflationary pressures, inventory provisions, elevated ocean freight rates and changes in foreign currency.
The company ended the quarter with $58 million in cash and cash equivalents and approximately $0.8 billion in long-term debt. The company has $40 million in outstanding borrowings under its line of credit facility and $448 million available for borrowing.
Inventories ballooned to $678 million, which was a 66% increase compared to the year-ago period. Approximately 90% of inventory at the end of the quarter was core product. The company stated it is taking proactive actions and expects inventory to return to more historical levels in mid-2023.
In a statement, CEO Scott Baxter said,“We expect challenging global macroeconomic conditions, particularly inflation, should continue to weigh on consumer discretionary spend, and ongoing inventory reduction actions will pressure near-term margins. However, we anticipate revenue to sequentially accelerate in the fourth quarter due to improved U.S. retail inventory levels, continued POS momentum, share gains and new business development activities. Further, our cash generation is expected to remain strong over time, giving us confidence in our capital allocation flexibility, as evidenced by our recently announced dividend increase.”
Valuation
The company gave guidance for revenue growth of 6% on a constant currency basis and earnings per share in the range of $4.35 to $4.40. Consensus analyst estimates are below that range at $4.28 for 2022.
That puts the stock trading at a low price-earnings ratio of only 10. The enterprise value/Ebitda ratio is also not elevated at approximately 8.
The GuruFocus discounted cash flow calculator creates a value of $54 using $4.28 as the starting point and only 5% long-term growth. The current stock price implies 1% earnings per share growth over the long term.
The company pays an annualized dividend of $1.92, which equates to an above-market dividend yield of 4.53% currently. The payout ratio is less than 50%.
Guru trades
Gurus who have purchased Kontoor stock recently include Joel Greenblatt (Trades, Portfolio), Robert Olstein (Trades, Portfolio) and Chuck Royce (Trades, Portfolio). Investors who have sold out or reduced their positions include Keeley-Teton Advisors, LLC (Trades, Portfolio) and Steven Cohen (Trades, Portfolio).
Summary
Kontoor Brands owns some of the most iconic and beloved apparel brands in the world. The Wrangler line of blue jeans and other apparel have been synonymous with Western American culture since 1947. It is currently the number two jeans brand in the U.S. The Lee brand, which has a rich heritage going back 130 years, is currently the leading denim brand in China.
This brand strength allows the company to generate significant free cash flow and provide a balanced approach to capital allocation. The significant headwinds the company is seeing at this time will recede at some point and the company will be able to resume its growth trajectory. This is appears to be an excellent entry point as a margin of safety has been created and there is likely support from the company’s high dividend yield.
