June 05, 2019 - 12:25am EST by
2019 2020
Price: 30.75 EPS 3.32 3.56
Shares Out. (in M): 56 P/E 9.3 8.6
Market Cap (in $M): 1,734 P/FCF 9.3 8.6
Net Debt (in $M): 936 EBIT 300 325
TEV (in $M): 2,671 TEV/EBIT 8.9 8.2

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  • Value trap



Here’s a terrible thought: Imagine inheriting your parent’s old stodgy jeans. Shareholders of VF Corporation are in exactly that position. VF Corp. (VFC) has just completed the spinoff of its jeans business, which is primarily comprised of the Wrangler and Lee brands. The new company has the catchy moniker of Kontoor Brands. (I dread to think how much the name consultants were paid for this one.) ­


That said, I believe that Kontoor at its current price represents excellent value, with the prospect of large capital gains, possibly more than 100%, over two or three years. While we wait for price appreciation, we will collect a hefty dividend that yields 7.3% at today’s price.


VFC has not invested in nurturing the highly profitable and cash-generating Wrangler and Lee brands in recent years, instead treating them as cash cows while focusing on its numerous other businesses and on acquisitions. This is reflected in the performance of its jeanswear division, with sales down about 10% over the last five years and operating income down from more than $500 million to less than $350 million over that period. During those five years, the parent invested less in cap-ex in the jeans business every year than the amount of D&A expense in that business. The division made aggregate net after-tax profits of about $694 million in the last three years, and I estimate that about $753 million of cash (i.e. more than 100% of profits) was transferred up to the parent during that time. And as part of the spinoff, Kontoor has taken on just over $1 billion of debt to make another payment to its now former parent.


In a situation like this, there is necessarily a leap-of-faith element that management can successfully execute to realize the potential that I see in the business. The higher the valuation, the greater the leap required. For this collection of assets, I believe that the stock price is cheap enough that the leap here does not have to be huge for this investment to work out well. The bad news (mature business, negative growth, aging brands) appears to have been priced into the stock, and there is now plenty of potential for pleasant surprises from an incentivized management team who can use the abundant free cash flow to create shareholder value through investments, dividends, and potentially stock buybacks down the road.



Kontoor‘s spinoff from VFC was completed on May 23rd. VFC cited the usual reasons for the spinoff: it allows each management team to focus on their separate businesses, pursue growth opportunities, capital allocation, appropriate incentivization of management, etc. My guess is that another unspoken reason is that despite its strong profitability, the jeans business is mature, with sales not only not growing, but declining in the last few years, and therefore dragging down VF’s overall growth rate. VFC has retained the rest of its vast portfolio of products, which include North Face, Timberland, Vans, JanSport, and many more.


The when-issued stock traded in modest volumes at just over $40 immediately prior to the completion of the spinoff. Since then the stock has declined virtually every day, losing almost 25% of its value in very heavy volume, to $30.75 currently. I suspect that there are multiple reasons for this decline:


(1)   Dumping of KTB by institutional shareholders and index funds. VFC is part of the S&P 500 index. Vanguard and Blackrock owned a combined 13.1% of VFC at end-2018. So they would have owned about 7.4 million of the 56.4 million shares of KTB outstanding, most of which they probably had to sell. At the 1:7 spinoff ratio, a shareholder who owned 7 shares of VFC worth about $596 today would now also own 1 KTB share worth less than $31, a ratio of 19:1. (VFC’s market cap is about $34 billion, compared with less than $1.75 billion for Kontoor.) It’s not hard to imagine many other large cap or more conventional funds and investors rushing for the exits.


(2)   Although the two brands (Wrangler and Lee) have been around for over 70 years and 130 years, respectively, and are household names (at least in the U.S.), the Kontoor name is virtually unknown to investors. Despite being a small-cap company, it should gradually become better known in the investment community because of its well-known brands.


(3)   The trade war with China and the threatened Mexican tariffs are bad for Kontoor, since most of its products are manufactured in Asia (by outside suppliers) and in Mexico/Central America (at the company’s manufacturing facilities). Competitors are likely to be similarly affected. My guess is that this is probably a short-term issue, though making predictions in this crazy political environment can be dangerous to one’s wealth. Over the longer term, production can be shifted to more cost efficient locations if necessary.


(4)   U.S. equity markets have been volatile over this period, possibly precipitating some selling by nervous investors.



The bulk of Kontoor’s business is from the Wrangler and Lee brands, which together account for over 90% of the company’s revenues. The Lee brand was created in 1889, and was acquired by a predecessor of VF Corporation in 1969. Wrangler’s jeans were first introduced in 1947, though the Wrangler brand had existed for some years before that. In 1986, VF acquired Blue Bell, which owned Wrangler, JanSport, and other brands. (VF is keeping JanSport and not spinning it off into Kontoor.) In addition to jeans for men, women, and kids, both brands sell other apparel (pants, shorts, denim jackets, shirts, tops, outerwear) and accessories (such as belts and caps).



Kontoor also inherited a third, smaller jeans and apparel brand, Rock & Republic, which is sold exclusively through Kohl’s in the U.S. Additionally, Kontoor also owns some smaller brands worldwide, including Gitano and Chic, though I think that both these brands are dormant. These are not important to my investment thesis.


The spinoff assets also include VF Outlet stores, which sell Wrangler and Lee products, other VF-branded and third-party products, and also serve as outlets for disposing of excess Wrangler and Lee inventory.


The table below provides a five-year summary of the financial performance of the businesses inherited by Kontoor, and a pro forma summary income statement for 2018, which adjusts for discontinued businesses and the debt taken on by Kontoor in the transaction. Pro forma EPS last year was $4.03, implying a P/E multiple of less than 8x 2018 earnings. Sales are expected to be lower in 2019 at about $2.5 billion. Earnings can be expected to decline too, and I expect EPS to be perhaps about $3.30 - $3.50. 2020 should be better.



Wrangler and Lee generated $1.6 billion and $960 million of sales, respectively, in 2018. The VF Outlet stores and other products accounted for the remaining $202 million of last year’s sales. The table below shows the revenues and operating profits by segment for the last three years. Sales have declined somewhat; operating profits have experienced a large decline, from $473 million in 2016 to $359 million In 2018. (Note: These numbers have not been adjusted for some spinoff-related accounting issues, so the numbers are not fully comparable to other tables in this report, but should give a good sense of the general magnitude, trends, and profit margins of the businesses.)