“We think about that a lot,” Scott Baxter, chief executive officer of Kontoor Brands Inc., told WWD of the threat of tariffs on Mexican imports to the U.S. being put back on the table.
While a wave of retailers have been scrambling to diversify their supply chains away from China as its battle with the U.S. escalates and more levies loom, the parent company of the Lee and Wrangler jeans brands has been grappling with other trade problems due to its reliance on Mexico.
Its sourcing footprint in China may be tiny, but more than a third of its total production is located in Mexico and Nicaragua and that became an issue earlier this year when President Donald Trump abruptly announced plans to unleash tariffs on Mexican imports in a bid to curb illegal immigration at the southern border.
The two sides subsequently came to an agreement, but Trump’s topsy-turvy approach on China shows that nothing is certain and his policies can change in the blink of an eye — or a tweet in his case — so Kontoor has been quietly developing a backup plan in the event that relations between Mexico deteriorate again.
“In our business continuity process, which we spend a lot of time on, we have scenarios in case that does come back and there are things that we’re able to do if that’s the case,” said Baxter in an interview to coincide with the release of the company’s second-quarter results.
It recently closed three facilities in Mexico, but according to Baxter, that had “nothing to do with tariffs.” He explained that those facilities produced a lot of goods for Vans and The North Face owner VF Corp, which Kontoor used to be part of, but since it spun off the jeans business into a separate entity earlier this year, those factories became surplus to requirements.
In addition to uncertainty over tariffs, Kontoor is also left in limbo in regards to the new trade agreement between the U.S., Mexico and Canada — known as the USMCA, which has yet to be ratified by legislators in both the U.S. and Canada. Mexico is the only country that has, to date, moved ahead.
Baxter, who has been spending a lot time in Washington, D.C., meeting with those in the know in the trade world, is hopeful that the legislation will be passed in the fall, following Congress’ summer recess, but if it doesn’t, Kontoor also has a plan B for this scenario.
The trade uncertainty came as Kontoor, which also owns Rock & Republic, got off to a tricky start in its first official quarterly earnings period as a stand-alone business, although it fared better than Wall Street had been expecting.
The Greensboro, N.C.-based company’s net revenue slid to $610 million in the quarter ended June 29, driven by the impact of Sears’ bankruptcy, actions to exit Turkey — an underperforming country for Kontoor — and foreign currency headwinds due to a strong dollar. On an adjusted basis, revenue was $602 million, beating analysts’ average estimate of $591 million, according to FactSet data, boosting its share price 15 percent to $34.16.
Within that, Wrangler’s global revenue decreased 8 percent to $364 million, while Lee’s slipped 5 percent to $207 million. On a geographic basis, U.S. revenue fell 3 percent to $487 million and international revenue was $123 million, down 25 percent.
As a result, net income was $38 million, or 67 cents a share, down from $60.5 million, or $1.07 a share last year. On an adjusted basis, it was 96 cents, also beating analysts’ estimates for 67 cents.
For the fiscal year as a whole, Kontoor is expecting revenue to exceed $2.5 billion, reflecting a mid-single digit decline compared with full-year 2018 adjusted revenue. Kontoor shares closed Thursday up 14% to $33.82.
Baxter concluded that he was optimistic about his plans for the company, which he hopes can capitalize off the resurgence of denim that had for many years trailed behind ath-leisure.
“The restructuring and cost-saving actions we’ve taken to simplify and stabilize the organization are paying off and are setting the foundation for improved profitability in the second half of 2019 and beyond,” he stressed. His plans include possibly withdrawing from unprofitable markets and launching Wrangler in China, where Lee has been successful. “We have the pieces in place and see a clear path to achieving our long-term revenue growth, margin improvement, and cash generation goals.”