Kontoor Brands, Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Kontoor Brands, Inc. is a global lifestyle apparel company, primarily known for its Wrangler and Lee branded denim jeans and apparel. The company also designs, manufactures, sources, markets, and distributes a wide variety of apparel, footwear, and accessories globally.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Kontoor Brands is a global apparel company that primarily operates in the design, production, and distribution of denim jeans and apparel, branded primarily under Wrangler and Lee. The company’s products are sold across the globe through a wide array of channels, including specialty, mid-tier, department, and mass retail stores, as well as through licensing arrangements and e-commerce platforms. Their global manufacturing footprint includes company-owned facilities and third-party manufacturers, but all are governed by strict quality control standards. A critical component of their operations also includes their strong global supply chain relationships.

The company operates in two main segments:

  • Wrangler: This brand is known for workwear, Western-inspired jeans and other apparel, as well as accessories that are primarily sold in the U.S.
  • Lee: This brand is focused on modern and urban fashion denim jeans, other apparel, and accessories. Lee primarily does business in Europe, Asia, and Latin America.

Industry Trends & Competitive Landscape

The apparel industry is competitive and undergoes constant shifts in consumer tastes and preferences. Key trends include:

  • Sustainability: Growing consumer awareness about the environmental impact of clothing, leading to increased scrutiny on supply chain transparency and sustainable production.
  • E-commerce Growth: Consumers are increasingly shopping online, requiring brands to have a strong digital presence and efficient e-commerce operations.
  • Casualization: More people are adopting casual wear, which boosts denim demand.
  • Supply Chain Disruptions: The geopolitical situation, including conflicts and regional instability, is increasing the risk of supply chain disruptions.
  • Pricing Pressure: The global retail environment continues to be highly price-sensitive, with constant competition from newer, cheaper brands and private labels.
  • Brand Power: Brands need a clear vision and strategy to not be substituted by another more popular brand and to fight ever-increasing competition.

KTB faces strong competition in all of its main regions and sales channels from a diverse set of competitors, ranging from established national and global apparel companies to mass-market retailers and niche private labels. Key competitors in the denim industry include Levi Strauss, VF Corporation, and Kontoor’s former parent company, VF Jeanswear. In specific product categories or regional markets, other brands and private labels also provide competition, especially for the company’s pricing power. The brand is becoming increasingly more important for manufacturers, as they have to fight against competition from cheaper labels and increased competition.

What Makes Kontoor Brands Different?

Kontoor Brands differentiates itself through:

  • Strong Heritage Brands: Wrangler and Lee both have long histories in the denim market and command brand loyalty from large customer base.
  • Global Presence: The company has a broad footprint spanning North America, Latin America, Europe, and Asia.
  • Multiple Distribution Channels: KTB utilizes a diversified approach for sales through wholesale, retail, and direct-to-consumer sales.
  • Strategic Innovation: The company is focusing efforts on sustainable and innovative clothing production.

Moat Analysis

Kontoor Brands has a relatively narrow moat (3/5) built on brand equity and its distribution networks, however, these are also easily disruptable.

  • Brand Recognition (Intangible Asset): Wrangler and Lee have long histories and global recognition, particularly in the denim market. These brands appeal to different consumer segments and have a certain level of customer loyalty, which gives them some pricing power. However, brand loyalty can fluctuate with trends and competitor actions.
  • Global Distribution Network (Scale Advantage): KTB’s extensive network of suppliers, distributors, and retail partners helps to create economies of scale. Having a strong global infrastructure means that the company can sell their products efficiently and effectively across a huge number of markets. But it does not guarantee competitive advantage, as others have also created similar networks.
  • Economic Moats and Competitive Advantage: In general, many apparel companies cannot maintain high ROIC consistently, as their competitive advantage is very weak and easily surmountable. They might get a huge jump in earnings if their brand becomes very popular for a short while, but eventually competition catches up and creates the same thing. KTB has a relatively more sustainable competitive advantage over competitors in the sense that Wrangler and Lee are well-known and respected brands, which are very difficult to replicate, but this has to be accompanied with a unique product to differentiate from its competitors (not just brand recognition) and with strong marketing to keep the brand on top of peoples’ minds.
  • Switching costs: The company has very low switching costs, as it can easily be replaced with a very similar product from its competitors. Because of this, its pricing power and profitability is directly influenced by the underlying competition.
  • Management: While management is quite important, it is not a moat. The company has been able to consistently create value and revenue growth with a solid ROIC, although it might not be as good as other companies in different sectors. Still, good management can be an advantage in a very competitive sector.

Moat Risks

  • Changing Consumer Preferences: Shifts in fashion trends and consumer preferences can quickly erode brand loyalty and profitability, requiring continuous adaptation and innovation.
  • Intense Competition: The highly fragmented apparel industry implies that KTB always faces tough competition from companies trying to gain market share with lower prices, superior products, or stronger marketing.
  • Supply Chain Vulnerabilities: Dependence on global supply chains creates risks related to price fluctuations of raw materials, tariffs, political instability, trade laws, and other geopolitical events.
  • Erosion of Brand Equity: Brands may lose their appeal due to mismanagement, changes in consumer perceptions, or the introduction of more relevant/popular brands.

Business Resilience

The company has shown resilience by continuously adapting to trends and by controlling its operating costs. KTB’s brand and global reach also help it maintain stability, but the company could be negatively affected by negative economic trends, trade disputes or changes in supply and demand patterns.

Financial Analysis

The following financial analysis is based on the latest Form 10-K and 10-Q filings and earnings calls.

Revenue Distribution

The company’s revenue distribution shows some clear patterns:

  • Channel Distribution: Over the past years, most of its revenues have come from U.S. Wholesale channels. It is an interesting note that its digital business has significantly increased, with direct-to-consumer e-commerce sales making a higher portion of total revenues than before, which is why these channels are prioritized by management.
  • Geographical Distribution: The revenues are mainly coming from North America, however, it does have a strong presence in other regions too. In those areas, the revenues from Latin America, Europe, and the APAC have been growing with a high potential for revenue growth in the coming years.

Margins

  • Gross Margin: In 2023, gross margins showed some volatility. There was a decline in gross margin in the second half of the year, partly caused by increases in raw material prices and other operational costs.
  • Operating Margin: The company has historically maintained a moderate operating profit, but is constantly under pressure to maintain this, with factors such as changing consumer preferences, competition, and various other factors affecting profitability.
  • Profitability: Profitability has been slightly decreased in the last years but is expected to be at a steady state in the future. Overall the company is profitable and has strong financials, but has to be careful with how management is directing their financial policy.

Latest Financial Information & Trends

  • Revenue: In the latest report released for the third quarter of fiscal year 2024, the revenue was $670.8 million, a 3.6% increase over the $647.5 million from the same period in 2023. This indicates an ability to grow revenues in difficult market conditions, which is a positive sign.
  • Gross Profit: The gross profit for the last quarter was 44.2%, which is similar to last year. This indicates a stable but not improving cost situation for the company.
  • Operating Expenses: In the same period, operating expenses increased from $181.1 million in 2023 to $191.6 million in 2024. Although, this resulted in a lower operating margin of 15.4%, compared to last year’s 16.7%. Therefore, KTB has to continue its effort on improving cost control.

  • Net Income: Net income for the last quarter was $44.4 million which resulted in earnings per share of 0.75. This number is not good at all, as it is substantially lower than last year’s $68.2 million and per share earnings of $1.16.

  • Long-Term Debt: Total long-term debt is $746 million. Although the company has enough cash to meet its short-term and long-term obligations, this could lead to high interest and finance charges in the upcoming year. The company is relying more on debt rather than internal funding or equity, which may increase risks to the business.
  • Share Repurchases: In the latest quarter, the company had bought back approximately 1 million shares of its common stock. They have spent a decent amount on share repurchases, and it will dilute per-share earnings and shareholder equity.

Recent Concerns

  • Supply Chain Volatility: Recent geopolitical events and economic conditions have disrupted global supply chains, affecting the sourcing and production and thereby revenues of companies such as KTB.
  • Economic Uncertainty: Current trends are pushing for lowered consumer confidence and spending which directly affects apparel companies in terms of lower revenues and high inventories.
  • Pricing Issues: The high competition implies that companies like KTB are facing higher pressures to keep costs down while not losing market share, which is tough in a high inflation and high operating costs environment.

Understandability: 2 / 5

Kontoor Brands is a relatively complex business to understand fully. The intricacies of supply chains, global distribution networks, and the impact of macroeconomic factors on their business make it more complicated. Although the basics of the business model are fairly simple, the complicated accounting (specially goodwill and amortization, share buybacks), financial statements and management calls require experience and patience to fully understand. While the business of selling apparel is simple at its core, nuances of competition and profitability are very difficult to grasp for an outsider. Therefore, it’s not a very easy to understand business.

Balance Sheet Health: 4 / 5

Kontoor Brands shows a reasonably healthy balance sheet with a couple of concerning signs.

  • Assets: The company’s current assets are substantial, primarily consisting of receivables and inventories, and indicate good liquidity in operations. However, this is largely influenced by current economic situation (recessions, oversupply etc.) which can easily change at any point. The company also has many intangible assets, largely goodwill, that are hard to liquidate. Therefore, a higher balance sheet volatility is expected from those assets.
  • Liabilities: Current liabilities are under control, but the total debt to equity level is somewhat high, and the company is increasingly relying on debt financing rather than internal profits to finance its growth, which is a risk.
  • Equity: The company’s equity has decreased somewhat over the last years, partly due to losses incurred by the company, which means that they have to focus on increasing net income rather than relying on leveraging.
  • Cash and Cash Equivalents: The company has a sufficient amount of cash to handle its day-to-day activities and short-term debts. However, having low levels of cash also signals that the company is not very flexible and has limited funds to deal with any unforeseen problems.

Conclusion

Kontoor Brands has a relatively narrow moat due to its brand recognition and distribution network, that could be easily eroded by changing consumer preferences or new competition, along with a solid financial structure that could be affected by high levels of debt and a dependence on outside financing. The business has a decent profitability and revenue growth, but it is dependent on the market conditions, competitors, and management’s ability to guide it through volatile times.