Kontoor: Wrangler, Lee and a Spin-Off in Denim

07/03/2019 5:00 am EST

Focus: CONSUMER

Richard Howe

CEO, Stock Spin-off Investing

VF Corp. (VF) spun off Kontoor Brands, Inc. (KTB) on May 22, 2019 and regular trading in the shares began the next day, explains Rich Howe, editor of the specialized advisory service Stock Spin-Off Investing.

After trading in the $40 range in when issued trading, Kontoor has fallen consistently since regular way trading began due to classic spin-off selling pressure.

Kontoor Brands is mainly comprised of the Wrangler and Lee denim brands. While these brands are not "hot", they are stable.

For example, revenue only declined by 11% during the Great Financial Recession. Further, denim has staying power. In 50 years, people will still be wearing jeans (although the styles will have changed).

Spin-offs usually unleash entrepreneurial forces as the spin-off is no longer weighed down by the bureaucracy of being part of a larger organization. This often results in the spin-off taking advantage of low hanging fruit that the parent company previously didn't prioritize.

An example of this is that Wrangler jeans are not available in China despite Lee being the leading denim brand in China. This will change in January 2020, when Wrangler will launch in China. Opportunities like this should improve KTB's revenue growth.

The quality of KTB's business is quite high as the business is not capital intensive; CapEx as a percentage of sales was only 0.80% in 2018. Historically, KTB has generated a return on equity of ~20%.

The stock's valuation is compelling. I expect $3.82 in adjusted EPS in 2020. Thus, the stock is trading at 7.6x 2020 earnings.

It pays an annual dividend of $2.24, and its dividend yield of more than 7% is quite juicy. Once word gets out that a stable business is trading with a 7%+ dividend yield, the stock will likely appreciate.

Management expected the stock to trade at a 5% dividend yield implying that management believes the stock is worth $44.80. My price target is $40 which implies 47% upside.

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