Unlike many other apparel companies that were affected by the United States' escalating trade war with China, Wrangler jeans parent Kontoor Brands (NYSE:KTB) cast a worried eye about the fallout of negotiations with Mexico.
Ten of its 13 factories were located south of the border, because Mexico is the largest supplier of men's and boys' jeans, representing about 35% of the total. Some 40% of the raw materials and finished products Kontoor uses and produces come from there.
Yet as the denim apparel company prepares to report its fourth-quarter earnings on Thursday, March 5, China may actually weigh most heavily on Kontoor's results.
Trading up for expansion
Like industry peers that source goods from China, Kontoor sidestepped pitfalls when the Trump administration negotiated trade agreements that ratcheted down the potential for a destructive trade war.
The U.S.-Mexico-Canada agreement that replaced NAFTA left many of the free trade provisions intact while ensuring goods still flowed fairly in all directions.
That allowed Kontoor Brands to focus on its expansion plans. Following its spinoff from VF Corp last year, the jeans company is looking to grow its presence in international markets. The U.S. represents 73% of total sales, but China is seen as a big growth market, because jeans from U.S. companies are still considered prestigious and carry a premium.
While Wrangler is primarily a U.S. brand, one that accounts for 58% of Kontoor's sales, the Lee brand generates 38% of revenue -- and most of that is from China. Kontoor saw an opportunity to expand Wrangler to the country and had been planning a major product rollout for the country, but that has all been thrown into doubt.
Big plans overseas
The Lee brand saw revenue increase 8% year over year in currency-adjusted sales in China during the third quarter, including a 10% increase in comparable-store sales, which CEO Scott Baxter said was "good news in advance of our on schedule launch of the Wrangler brand in China in early 2020."
Kontoor said its go-to-market strategy was focused on digital, and it had partnered with a large digital company for the effort. Although it didn't mention who the partner was, former parent VF Corp announced last summer it had hooked up with e-commerce giant Alibaba, and was using its research and development arm, Tmall Innovation Center, to design products for local customers.
VF Corp has worked with Tmall in the past to design new clothes for its Dickies and Kipling brands, and it wouldn't be surprising if Kontoor was doing something similar to get Wrangler off to a strong start.
Resorting to plan B
Now with the coronavirus outbreak and the closure of numerous businesses and industries in China, the Wrangler rollout could be significantly delayed. A Kontoor spokesman wasn't able to comment directly on any possible impact the contagion's spread might have but shared that the company was monitoring the situation closely.
That means Kontoor may have to rely upon the other two planks of its growth strategy, which are brand extensions, such as getting into tops and outerwear, and new distribution channels, particularly direct to consumer.
The wholesale channel, which includes sales to department stores and retailers, is still Kontoor's biggest source of revenue, representing 85% of total sales, but it has been hurt by the Sears bankruptcy, which despite having occurred in 2018, still affected Kontoor's sales by two percentage points last quarter.
However, the fourth quarter will represent the period where it finally laps the impact of the retailer's collapse, which could provide a boost as it's able to reach consumers through different avenues.
The financial impact the coronavirus has on Kontoor Brands probably won't be seen until it starts reporting its 2020 results, since the worst effects didn't rear up until January. Yet it will likely have upset the rollout of the Wrangler brand in China, and investors should keep an eye on what management has to say about where it goes in the future.