2023-07-06 23:54:04 ET
Summary
- Levi is a very inexpensive consumer stock, needlessly sold off amid strong margins and decent revenue growth.
- Q2 results were below expectations but spending will rebound as people continue with wardrobe refreshing.
- LEVI stock is trading at a value multiple, even though it should continue to grow over the next few years through economic weakness.
Levi Strauss & Co. ( LEVI ) has been a resurgent brand over the past number of years, following a successful 2019 IPO. Denim is back in a big way as Generation Z is embracing the fashion of the 80's and 90's. The company leads the denim industry in 18-30 market share, giving them great potential for the next 5 years as they increase wallet share. The company is executing well with an increased direct to consumer model, improved e-commerce sales and returning capital to shareholders. The stock has potential for an explosive move higher once the sector turns, and those who are patient will be well rewarded. We are continuing to see decent earnings from apparel brands amid very difficult 2022 comparisons. Customers continue to spend and refresh wardrobes although at a slower pace than in 2022. Diving into the 2nd quarter results just released shows that continued solid performance, but the stock is down 7.5% afterhours on lowered earnings guidance. While additional 2023 risks of student loan payments and a weakening job market loom, the stock is trading at a very low multiple that makes it a good buy candidate for long term focused investors. Combined with the recent reduction in price, LEVI is a buy the dip candidate below $13 with these Q2 results.
Solid Q2 even with slower consumer spending
Levi put together a disappointing second quarter, but not without its bright spots. Revenues came in at $1.34 Billion, down 9% over the prior year at constant currency as the company moved wholesale sales of $100m forward to Q1. This was due to adding a new ERP system which can cause issues in implementation. Asia was a positive standout with 27% growth at constant currency. China is a long term growth driver and the reopening of the economy was a positive benefit here. However, at $262 million which is more lower than Europe or North America plus currency headwinds, Asia wasn't able to move the needle enough. Europe fared well in Q2 as it was down 2% at constant currency, and actually up 1% when removing Russian sales. Europe is facing even worse inflation than the United States and didn't have the same increase in savings rates as the US in the pandemic. LEVI of course left Russia since 2022 Q2 with the company pulling out of the region since the war began. North American sales were down 22% but that was due to Q1 pull forward as DTC was still up a solid 6% in the continent. Fear about weakness in this region is likely the big reason for the after hours drop, as it has led to a small guidance cut from 1.5-3 to 1.5-2.5% revenue growth.
Overall the gross margin performance was impressive with 58.7% margins doing quite well and up year over year. Part of this is the higher DTC sales and lower wholesale sales in the quarter. Also margins were boosted by price increases in some areas and less air freight used to move product globally. Below you can see margins have flattened out in recent quarters and the company is now able to grow those again as freight comes back to 2019 levels. The other positive on margin was reasonable promotional activity - a good sign of a strong demand environment. Inventories are still elevated at $1.31B but are down $97 million since Q4 and should improve throughout 2023. Management has inventory matching the sales growth rate by the end of 2023, meaning 2024 won't have any promotional overhang from sales to clear stale product.
Operating income is the most important thing long term and that has seen pressure in 2023 due to higher costs. Operating income was just $9.9 million down from $76.2 million last year. While this drop is significant, the pull forward of sales in Q1 explains some of the weakness here. Long term income will be benefit from direct to consumer revenues keeping margins high and increasing scale allowing SG&A to become a lower portion of revenues. 2024 is expected to have over 10% earnings growth with the stock trading at 10x that is a bargain even in a sector like consumer discretionary.
As you can see above the stock has seen growth return to low single digits after a strong pandemic bump. The stock has solid margins which have the ability to move up longer term. The stock is trading at 10.5 times trailing earnings, a value stock level although the company has significant secular growth potential. This is below the wider retail multiple of 12.1x earnings, despite LEVI being a premium brand with high end margins. The coming return of student loan payments in October 2023 will be a headwind, but the stock is priced for this. The market is only expecting 2.5% revenue growth this year, a level that should be very beatable with only Q4 seeing loan headwinds. XRT which is the wide retail ETF is up 7% year to date, making a rebound in LEVI stock likely as the guidance now factors in a more pessimistic outlook and the shares have rerated lower. LEVI management has been a bit sluggish buying back shares with no repurchases in Q2 despite $471 million in cash on hand. Look for investors to pressure management on this issue with the stock trading at a similar multiple it did in March 2020 with the world in chaos.
Buy the dip after Q2 earnings
Levi's is trading at 10.5x earnings with a premium brand, solid margins and has underperformed so far this year with a lower than -10% year to date return. At under 10x forward earnings, the stock is trading just above it 2020 and 2022 trough multiples even in the recent strong market. Management is still confident of a revenue growth and earnings growth in 2024 which should support the stock here. The stock should see reversion to the mean, with a mid-teens multiple for LEVI a fair price in this high rate environment. A 15x multiple with the reduced EPS guidance of $1.15 for 2023 has the stock trading back at $17 per share - a level it held through all of 2021 and 2022. As a long term hold the company pays a solid 3.4% yield at this level with potential to grow it in the long term. The company has hit a lull for 2023, but those with a longer term outlook would be wise to consider LEVI before the market moves back into the name. Margins continue to hold strong, and the company will come out of this period stronger as the core demographics continue to flock to denim.
For further details see:
Levi Strauss: Buy The Dip After Disappointing Q2 Print