Jeans maker Kontoor Brands (KTB) has been on a roll in the past several months. The company’s shares were decimated in the early days of the pandemic crisis, but after making a solid bottom in the area of $14 back in May, the stock has been strong.
Apparel stocks were crushed back in March because stores were closed, and with stay-at-home orders in place, there was simply no reason to buy new clothing. That has changed, however, and Kontoor has responded accordingly.
We can see that the clothing group has outperformed the S&P 500 since the bottom, beating an impressive gain by the broader market by nearly 20%. This group, then, has been a very strong one to pick stocks from in recent months.
In the bottom panel, we can see that while Kontoor underperformed its peer group at the start of the year, it has made up a lot of ground of late. Thus, we have a strong stock within a strong group, which is exactly the kind of stock I want to own. This alone does not make a stock a buy, but it is a great starting point.
Back in May, when the pandemic selloff was nearing exhaustion, I wrote that Kontoor represented deep value. The idea was simple; the stock was being priced like a recovery would never come, which seemed highly unlikely. Shares were way too cheap, and since my buy call, the stock is up more than 100%. That’s great, and since I’m a long way from all of my calls being winners, it’s a nice affirmation to get a home run like this one. However, when a stock has doubled in the space of a few months, it is worth revisiting to see if the bull case is still intact.
In short, I think the fundamental case for Kontoor is still very much intact. Consumers have proven they will use their spare cash to buy furniture, cars, boats, or anything else they want in lieu of spending on things like commuting, ordering lunch at the office, vacations, and all the other things that have been reduced due to this new way of life. That includes apparel, and we’ve seen many kinds of apparel makers thrive in this environment, with jeans makers being one.
Indeed, Levi Strauss (LEVI) reported a Q3 profit and strong guidance just a few weeks ago, a business that is very similar to Kontoor. Given the run-up in the share price for Kontoor, it seems to me institutional investors are betting on a strong report when Kontoor comes out with its own earnings on the 29th, so I certainly wouldn’t be surprised to see a similar story from Kontoor as what we saw from Levi Strauss.
I also think we could get some kind of news on the previously-suspended dividend when Kontoor reports. The company suspended its payout during the worst of the early days in the pandemic and hasn’t reinstated its payout. However, with strong earnings on tap and much more clarity into the recovery, I don’t see any reason Kontoor should continue to hold back. If we get an announcement on the return of the dividend, that would be another positive for the stock.
Of course, when a stock has doubled, the obvious thing to do is to examine the valuation. When we look at the valuation in May – which has been copied from my linked article above – it is easy to see why I said Kontoor offered deep value.
Source: Seeking Alpha
The valuations on future earnings were patently absurd at the time, with the stock trading for 5 times forward earnings.
If we look at the same numbers today, the valuation has obviously soared, but we are still at very reasonable levels.
Source: Seeking Alpha
EPS estimates for 2021 and 2022 are substantially the same as they were five months ago, so the valuation has increased significantly. However, we’re still talking about ~12 times earnings for both years at the current valuation, and that’s after the stock has doubled.
Source: Seeking Alpha
It certainly appears to me that the downward revisions in EPS have ceased, as estimates for 2021 and 2022 have flattened out and moved slightly higher. That means we shouldn’t see any nasty downward surprises, and given the strength from Levi in the past couple of weeks, I’m a little surprised estimates haven’t risen more than this for Kontoor.
The good news is that even with Kontoor’s valuation having soared, it is still a lot cheaper than LEVI, which is trading for 17 times next year’s earnings and 14 times 2022 projections. Kontoor is trading for about a 30% discount on 2021 earnings to LEVI, and about 15% to 2022. That does not guarantee that Kontoor needs to trade at exactly the same valuation, but it is a very interesting yardstick to measure by.
The bottom line
Given the fact that Levi Strauss reported outstanding earnings earlier this month, the fact that we’re continuing to see a strong rebound in apparel stocks in various sub-sectors, Kontoor’s still-cheap valuation, its discount to Levi Strauss, the idea that the dividend could be reinstated, and the fact that earnings revisions have stopped moving down, I still think Kontoor is a buy.
To be perfectly clear, Kontoor is nowhere near as good of a buy as it was back in May, and I don’t think it is deep value any longer. However, the stock still looks relatively cheap, and with the prospect of the dividend on the horizon, I still think it is attractive.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.