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Kontoor Brands Cleans Up Its Balance Sheet, But Sales Woes Remain

By Asit Sharma – Aug 6, 2020 at 3:16PM

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The denim wholesaler's latest earnings report is both characterized and undermined by uncertainty.

Kontoor Brands' (KTB -4.17%) second-quarter 2020 results, issued Thursday before markets opened for trading, reassured investors that its liquidity and solvency outlook remains intact. Given its current balance sheet and cash flow generation, the company should be able to weather the next several quarters as the coronavirus pandemic drags on.

However, the owner of the esteemed Lee and Wrangler jeans brands continues to struggle with a demand picture that falls largely beyond its control. Below, let's delve into the company's latest financial scorecard to understand how it might fare in the back half of 2020.

Various styles of blue jeans hang on a sale rack.

Image source: Getty Images.

Anemic sales, but several bright spots

Kontoor Brands' revenue plunged 43% against the prior-year quarter, to $349 million. The company operates under a primarily wholesale model: Sales to department stores and other retailers made up 88% of its top line over the last three months. This channel remains under pressure as the coronavirus pandemic continues to limit in-person shopping around the world. U.S. wholesale revenue dropped by 39% to $253 million versus the second quarter of 2019, while international wholesale revenue decreased by 50% to $44 million.

Surprisingly, despite deflating sales, the company's gross margin declined just 10 basis points from the comparable quarter to 38.5%, and, on an adjusted basis, by just 160 basis points to 38.4%. Kontoor Brands was able to stave off greater margin compression from its faltering top line through "improvement from restructuring, quality-of-sales initiatives, pricing, product cost enhancements and improving channel mix." The company's gross margin performance over the last three months bodes well for future profitability once sales rebound. 

Similarly, management was able to control overhead, as selling, general, and administrative expenses declined by 14% to $156 million. Kontoor posted a net loss of $33.3 million against a profit of nearly $38 million in the second quarter of 2019, but its gross margin stability and lower fixed cost base averted a potentially steeper loss on the bottom line.

During the quarter, Kontoor paid down $175 million against short-term borrowings in conjunction with an amendment to its credit facility. Management made an additional discretionary payment of $75 million, reducing the company's revolving credit balance to $225 million, with $273 million remaining to draw on the facility. Kontoor thus reduced its debt from a peak of $1.4 billion in the previous sequential quarter (Q1 2020) to roughly $1.1 billion. Kontoor Brands shareholders should note that the payments on the amended credit facility pave the way (per the agreement) for a restoration of the company's suspended dividend later this year -- should management deem it financially feasible to resume payments to shareholders.

The company also shored up its balance sheet by optimizing inventory and focusing on cash collections. Inventories declined by 20% from the prior-year period to $433 million, indicating that Kontoor Brands is adjusting raw materials and finished goods production to find an equilibrium point given lower sales levels. Accounts receivable declined by $60 million sequentially from the first quarter, to $153 million. Unlike some of its consumer discretionary peers that are taking a lenient stance with customers, Kontoor Brands appears intent on keeping a firm payment policy during the pandemic. The collection of $60 million of accounts receivable this quarter helped Kontoor turn cash flow-positive for the first six months of the year -- the organization eked out $4.4 million in operating cash flow in the first two quarters of 2020.  

Looking forward

Kontoor Brands refrained from issuing quantitative guidance on Thursday. Management did note, however, that revenue in the second half of 2020 "should experience sequential year-over-year improvement and is expected to benefit from new programs and distribution gains, as well as the timing shift of shipments." 

Unfortunately for the company, it's increasingly difficult to predict when global retail consumption patterns will stabilize and improve. This uncertainty continues to trouble shareholders. Shares of Kontoor Brands have lost 52% of their value so far this year, including a 6% drop in late morning trading on Thursday. Given its relatively solid financial position, the "KTB" symbol may be a candidate for value-oriented investors who don't mind enduring a potentially extended wait for a share-price resurgence.

Asit Sharma has no position in any of the stocks mentioned. The Motley Fool recommends Kontoor Brands Inc. The Motley Fool has a disclosure policy.

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