Short KTB: Front-run ETF Selling

Summary

Recently, Kontoor Brands (disclosure: we are short KTB) suspended its dividend.

As a result, a dividend focused ETF, SDY, will likely sell the 9.1 million shares of KTB that it owns by tomorrow end of day.

Average daily trading volume for KTB is 1.4 million shares so 9.1 million shares is a lot of shares for the market to absorb.

This selling pressure will likely drive KTB lower over the next few days.

Shout out to Low Tide Investments who flagged this situation.

Background on KTB

Kontoor Brands (KTB), a stable apparel company that sells denim under the Wrangler and Lee brands, is a company that I know well.

I’ve covered it since it was spun off from VF Corp (VF) last year.

Consistent with other apparel companies, KTB has been hit by the COVID-19 driven economic lockdown.

As a result, KTB amended its debt covenants to increase liquidity, a move that I believe was prudent.

But the downside of the increased liquidity is KTB had to suspend its dividend.

Management is adamant that it wants to reinstate its dividend (potentially as soon as Q4 2020), however, the suspended dividend means that the S&P Dividend ETF (SPY) will likely sell its KTB shares by month end.

More Information on SDY

The SPDR S&P Dividend ETF (SDY) invests in high dividend yielding securities.

Per its prospectus, if a dividend is cut or suspended, the ETF will sell its holding in the security prior to the first day of trading of the following month. Here is the language from its prospectus:

If between annual reviews the Index Provider (as defined below) determines, based on publicly available information, that an Index constituent has eliminated or suspended its dividend, omitted a payment, or reduced its calendar year dividend amount and will no longer qualify for the Index at the subsequent reconstitution, the Index constituent will be removed from the index effective prior to the open of the first business day of the following month.

As of yesterday (holdings are disclosed daily), SDY owns 9.1 million shares of KTB (as noted above).

SDY has only sold ~650,000 KTB shares since the announcement.

Low Tide Investments is tracking SDY’s holding of KTB.

Does SDY Have to Sell KTB?

In short, no.

There is a provision in its prospectus that states 80% of its assets in securities are composed of the S&P High Yield Dividend Aristocrats Index (see language below).

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As such, the ETF has a bucket of 20% of assets that could potentially not pay a dividend. In theory, SDY has the flexibility to retain its stake in KTB. However, I believe it’s likely that it will sell its shares. Why would a high dividend yield ETF maintain a holding in a stock that doesn’t pay a dividend?

Further, SDY’s holding of KTB shares is worth $136 million, less than 1% of the ETF’s $14 billion in assets. As such, I don’t think the ETF will be too sensitive to price when liquidating its KTB shares.

Finally, KTB’s market cap is currently $881 million, below the index’s $1.5 billion minimum threshold. This is another reason why the ETF will likely sell its shares.

Conclusion

Given technical selling pressure, I believe KTB is a good short candidate over the next two days.

This is a short term trade so it only applies to you day traders out there!