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Saggy Global Sales Gave Kontoor the Q1 Blues

Sagging international sales gave Kontoor Brands Inc. the Q1 blues.

In a Nutshell: “Increases domestically were muted by expected softness in international markets,” Scott Baxter, Kontoor’s president, CEO and chairman, said in a statement.

International wholesale sales reflected Covid-policy changes in China, although international sales were somewhat offset by strong direct-to-consumer (DTC) performance. The company said international DTC sales rose 10 percent, or up 17 percent in constant currency. In China, international wholesale sales fell 36 percent from year-ago levels, while DTC sales there rose 3 percent. In Europe, sales fell 7 percent versus last year, with wholesale pressures offsetting DTC gains.

“Within international, we are seeing great signs in Q2 that China is recovering at a faster pace than we previously expected and we now anticipate significant gains in the second quarter, with momentum carrying into the second half,” Baxter told investors in a conference call Thursday. “These actions, improving fundamentals, when coupled with our fortified balance sheet and strong cash generation afford us great flexibility to deliver in the face of uneven conditions.”

Looking ahead to 2023, Baxter said the company is gaining market share through “investments in innovation, elevated design, and demand creation.” Category extensions both diversify the product portfolio and take Kontoor’s brands to new points of distribution. “Globally non-denim long bottoms grew 15 percent in the quarter, while outdoor and workwear each increased 17 percent over last year,” Baxter said.

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He addressed Wrangler and Lee’s allocated selling space at Target, saying the retailer is a long-standing customer. “Our non-denim assortment in Target has grown nearly 25 percent annually,” he said.

Reintroducing the Lee Rider jacket helped stimulate brand heat, said Baxter, speaking to Kontoor’s strategic partnerships and efforts to build brand equity. Channing Tatum wore in Lee in Vanity Fair and Pedro Pascal slipped into vintage Lee jeans for an Esquire shoot. He said 2023 will see more collaborations with global and culturally relevant brands, such as the recently launched Dragon Ball Z and the upcoming partnership with Bearbrick, the popular brand of collectible toys.

Wrangler just signed country music singer Lainey Wilson as its women’s brand ambassador. “Lainey continues our legacy of partnering with authentic brand ambassadors that embrace the core while simultaneously broadening and enhancing Wrangler’s reach to a whole new audience,” Baxter said. “The brand will deepen its focus on the music scene in 2023 by continuing to activate unique brand partnerships.”

Baxter said the pipeline for collaborations and partnerships includes Inditex’s Pull&Bear and bourbon distillery brand Buffalo Trace.

Retailers are still figuring out their inventory before they commit to new wholesale orders. “We have factored that into our plans accordingly and we are amplifying our actions with our own inventory, managing our internal production with plans to have year-over-year growth in line with revenue growth during the third quarter,” Baxter said.

The company expects gross margin expansion in the second half to be driven by geographic and DTC mix, normalizing production and reduced input cost pressures.

In addition, inventory at the end of the first quarter was $660 million, up 52 percent compared with the prior-year period. “Nearly 90 percent of inventory at the end of the first quarter was core product,” Kontoor said. “The company is taking proactive actions and expects inventory growth to be in line with sales growth by the end of the third quarter of 2023.”

Wells Fargo retail analyst Will Gaertner highlighted Kontoor’s “surprising” first quarter revenue and earnings per share (EPS) miss, but pointed out that management’s execution in the face of a difficult environment has been impressive over the past 6-8 months. First quarter results show that “even the best operators are not immune to this difficult macro backdrop,” he said. “However, Kontoor continues to gain share, China is inflecting and structural revenue and top-line drivers are very much intact.” Gaertner has the equivalent of a “Buy” rating on shares of Kontoor.

Net Sales: Net revenues fell 1.9 percent to $667.1 million for the three months ended April 1 from $679.7 million in the same year-ago quarter.

As for revenue by channel, U.S. wholesale revenue—primarily the Wrangler and Lee brands—rose 1.3 percent to $476.2 million, while non-U.S. wholesale fell 18.3 percent to $117.9 million. DTC sales rose 11.6 percent to $73 million from $65.4 million. Wrangler brand global revenue posted a 3 percent increase to $423 million in the quarter, while Lee brand global revenue reported a 9 percent decrease to $241 million.

By geographic region, U.S. revenue rose 2.2 percent $518.1 million, while international sales fell 13.7 percent to $149 million.

Earnings: Net income fell 18 percent to $66.3 million, or $1.16 a diluted share, from $80.8 million, or $1.40, in the same year-ago period.

Wall Street was expecting diluted earnings per share of $1.18 on revenues of $675.5 million.

The company reaffirmed its prior outlook for Fiscal Year 2023, which was disclosed Feb. 28 when the company posted fourth quarter results. Revenue is expected to increase at a low-single digit percentage over 2022, with the “first and second half performance relatively balanced,” the company said. EPS is expected to be between $4.55 to $4.75.

Kontoor’s first half is expected to be driven by U.S. momentum in point-of-sale (POS), share gains and DTC.

The company also said second quarter U.S. performance to be tempered by shipments continuing to lag POS, with China expected to see stronger growth in the quarter. Looking to the back half, Kontoor said it is expecting that “macro consumer demand conditions will be more challenged in the U.S., with the China market more fully reopening.”

CEO’s Take: “We continue to assume macroeconomic pressures will weigh on consumer demand in the second half of 2023, particularly in the U.S. However, we believe that our increasingly diversified growth across channels, categories and geographies, enabled by strategic investments in DTC, demand creation and data analytics will generate more sustained, profitable growth over time,” Baxter said.