3 Reasons KTB is Risky and 1 Stock to Buy Instead

Over the past six months, Kontoor Brands has been a great trade, beating the S&P 500 by 5.9%. Its stock price has climbed to $66.10, representing a healthy 15.7% increase. This run-up might have investors contemplating their next move.

Is now the time to buy Kontoor Brands, or should you be careful about including it in your portfolio? See what our analysts have to say in our full research report, it’s free.

Why Do We Think Kontoor Brands Will Underperform?

We’re glad investors have benefited from the price increase, but we're sitting this one out for now. Here are three reasons why KTB doesn't excite us and a stock we'd rather own.

1. Weak Constant Currency Growth Points to Soft Demand

Investors interested in Apparel and Accessories companies should track constant currency revenue in addition to reported revenue. This metric excludes currency movements, which are outside of Kontoor Brands’s control and are not indicative of underlying demand.

Over the last two years, Kontoor Brands’s constant currency revenue averaged 3.1% year-on-year growth. This performance was underwhelming and suggests it might have to lower prices or invest in product improvements to accelerate growth, factors that can hinder near-term profitability.

2. Mediocre Free Cash Flow Margin Limits Reinvestment Potential

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

Kontoor Brands has shown poor cash profitability over the last two years, giving the company limited opportunities to return capital to shareholders. Its free cash flow margin averaged 13%, lousy for a consumer discretionary business.

3. New Investments Fail to Bear Fruit as ROIC Declines

We like to invest in businesses with high returns, but the trend in a company’s ROIC can also be an early indicator of future business quality.

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, Kontoor Brands’s ROIC has decreased over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.

Final Judgment

Kontoor Brands doesn’t pass our quality test. With its shares beating the market recently, the stock trades at 10.7× forward P/E (or $66.10 per share). This valuation is reasonable, but the company’s shaky fundamentals present too much downside risk. There are better stocks to buy right now. Let us point you toward the Amazon and PayPal of Latin America.

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