2023-06-02 04:14:04 ET
Summary
- Levi Strauss & Co. is a clothing company that designs, markets, and sells apparel and accessories for men, women, and children.
- Levi is extremely attractive financially, with a GPM of 58% and an EBITDA margin of 14% in FY22. This is more than many of its peers.
- The company has little debt and has been deleveraging. Levi should be able to maintain healthy dividends and buybacks.
- Short-term headwinds could drive the share price down in the coming 12 months.
- Our valuation suggests an upside of 14%, with Wall St. seeing 38%.
Investment thesis
Levi is a household name that has managed to remain relevant for many decades. The company's listing was shortly before the onset of the pandemic, making it difficult for the market to truly assess the asset. What we can see is that Levi is generating far more profits and revenue than it did when listed but is now cheaper. Our objective is to conduct a deep dive into the company's financials, focusing on if Levi represents an investable company from a financial perspective.
Company description
Levi Strauss & Co. ( LEVI ) is a clothing company that designs, markets, and sells apparel and accessories for men, women, and children across the Americas, Europe, and Asia. Their product offerings include jeans, casual and dress pants, activewear, tops, and related products under their brands. The company also licenses its trademarks for various product categories. The company has approximately 3,200 brand-dedicated stores and shop-in-shops.
Share price
Levi's share price has performed poorly since listed, losing 28% of its value in the last 4 years. The company has struggled to achieve attractive financials while achieving impressive growth. This said COVID has not helped.
Financial analysis
Levi Financials ( Tikr Terminal )
Presented above is Levi's financial performance for the last decade. Overall, we are pleasantly surprised by how Levi has done.
Revenue has grown at a CAGR of 3%, driven by a several factors. Firstly, the company has focused on DTC sales (38% of net revenue in FY22), which is generally more lucrative as it cuts out the middleman. Not only this but it creates long-term value by offering consumers a tailored service. Secondly, Levi has increased its international business, allowing for growth in its total addressable market. This is a unique proposition for Levi as the brand has outsized international exposure compared to other brands of a similar size, due to it famously inventing blue jeans. As of FY22, 53% of business is generated from international regions. Finally, the company has expanded its product offering, now generating 40% of its revenue from products other than jeans. This is highly beneficial as it diversifies the company's revenue stream while also leveraging its brand to expand into lucrative areas. An example of this is Women's apparel, with Levi expanding into Women's leggings. This is highly lucrative as Women make the vast majority of retail purchases and so they are again increasing their total addressable market by a substantial amount. Despite demand beginning to slow, and the company achieving 7% growth at the top line, Levi's Women's business grew 12% Y/Y.
Levi is also producing impressive gross profits, with a margin of 58%. This is a highly impressive level, reflecting the company's brand image in the market. Levi's denim is known to be of the highest quality, with consumers willing to pay a premium for what they believe to be a premium product. What we find surprising is that while many retailers are suffering from margin contraction, Levi has achieved consistent GPM expansion. Even in the short term with inflationary pressures, the company has remained impressively robust.
The company is not immune to inflationary pressures, however, with S&A expenses increasing as a percentage of revenue. Across the 10-years, these expenses have increased by 6%, which is a fairly large amount. In the most recent period, the increase has been 1%. Our view would be that a sub-43% level would be attractive, which suggests a noticeable underperformance. Management attributes this to two distinct types of expenses. Firstly, short-term headwinds, with greater distribution expense. Secondly, strategic investment in the company's IT system and DTC business. We would look to see this expense decline in the coming periods.
Despite these factors, EBITDA margins have generally trended upward, with the company achieving 14%. This is primarily driven by the production gains, distribution mix ((DTC)), and pricing power. With an EBITDA margin of 14% and an NI margin of 9%, our view is that the company is highly attractive in the retail space.
FCF margins are 0%, driven by a large accumulation of inventory, in conjunction with an uptick in Capex. On a normalized basis, the company has shown the ability to achieve in the region of 4-8% consistently, which again is impressive.
Moving onto the balance sheet, this inventory accumulation is seen with Levi seeing its inventory turnover declining and CCC increasing. This could pose short-term headwinds if the company struggles to see this stock, resulting in greater discounting of products. With a GPM of 58%, the company can do so, although it certainly would not be preferable.
Management's quality leadership extends to the capital structure, with the company continuing to deleverage its small debt balance (The uptick in FY20 relates to accounting changes). With an ND/EBITDA ratio of 1.3x, Levi is positioned flexibly for any opportunities or threats.
The pandemic year aside, Management has been active in rewarding investors with these returns, growing dividends, and buying back shares. Our view is that this should remain sustainable over the medium-term as cash generation remains strong.
Overall, we are very impressed with Levi's financials. The company is highly profitable and positioned well to distribute to shareholders sustainably. In an ideal world, growth would be slightly higher and the biggest risk is the accumulated inventory as of Nov22.
Q1
Presented above is Levi's Q1 results. To summarize, they were bad, very bad. The share price declined over 10% on the news and has yet to recover.
Although revenue remained resilient, the company experienced a noticeable reduction in margins across the board. Everything that can go wrong from a margin perspective did. Greater production costs, more discounting, and greater marketing spending.
Many retailers are struggling currently and in our view, a quarter such as this was inevitable. The key for the company now is to show that margins can be recovered.
Outlook
Presented above is the consensus Street view on Levi's financial performance in the coming 5 years.
The top-line view is highly bullish, forecasting an 8% growth rate. This will be driven by greater growth in its international business, alongside its Other Brands segment. Sales in Asia grew 22% on a constant-currency basis, with the Other Brands segment achieving 25%.
Levi's margins are not expected to expand substantially, likely given the impressive levels at FY22, leaving little gains on the table in the short term. The key is that contraction is not forecast, which suggests analysts expect the quarter to be an outlier.
Management's guidance for FY23 is $6.3-6.4BN, with analysts coming in at the bottom end. This is a reflection of weaker economic conditions, which we do concur with. This suggests a risk around revisions.
Retail peer analysis
From an objective standpoint, we are impressed with Levi. This does not necessarily mean the company is an attractive retailer as this would require us to compare the company to its sector peers. We have presented this below.
Profitability
What we observe is that Levi stands up extremely well. The company is far more profitable on a GPM basis, which allows the business to translate the gains across the bottom line. These returns are efficiently produced, with the company scoring well across the efficiency metrics. Further, we know that FCF is far below Levi's normalized level, which means the fundamentals of the business outscore this rate. Not only this but the sector metrics are derived from the "Consumer Discretionary" sector, which includes the likes of Amazon ( AMZN ), Airbnb ( ABNB ), LVMH ( LVMHF ), and Kering ( PPRUF ). Although these businesses are comparable in nature, they are far more profitable, which highlights how well Levi is performing.
Growth
As we have mentioned previously, Levi's growth rate is respectable but leaves a little more to be desired. Seeking Alpha's rating concurs with this view, giving the company a B rating. Again, the company is in a sector with many high-growth businesses that are less comparable to Levi, who is a traditional mature retailer. If we Levi to NIKE ( NKE ), adidas ( ADDYY ), or V.F. Corp ( VFC ), the company outperforms them all on this metric.
Valuation
Presented above is Levi's valuation relative to its sector. The company is currently trading at 9x its LTM EBITDA, a 12% discount to the market. Moreover, the company is trading at a substantial discount to its 5Y average. This is likely a reflection of the current bear market and investors pricing weaker consumer demand. Regardless, the market suggests Levi is trading at a discount.
To cross reference this, we have conducted a DCF valuation of the business.
Our key assumptions are:
- Revenue growth of 4-8% in the coming 5 years, with a weaker FY23 than analysts have forecast.
- FCF conversion improving to 6-7%.
- A perpetual growth rate of 2.5%, an exit multiple of 9x, and a discount rate of 9%.
Based on this, we derive an upside of 14%. The Street is more bullish, with a target upside of 38%. Based on the valuation, in conjunction with the current financial performance, we see sufficient evidence to assign a buy rating.
Short-term headwinds
Readers looking to time their investment would do well to consider the short-term headwinds/factors the company is facing.
Weaker retail conditions
We are currently experiencing a weaker trading environment. Inflationary pressures are deteriorating consumers' real income, with interest rates compounding the impact. Many consumers are turning defensive, reducing their discretionary spending in response. Further, we have seen a record level of credit card balances, suggesting consumers are maxing out their spending to meet living costs. This could mean declining revenue growth in the coming quarters, with Levi's premium pricing encouraging consumers to defer spending. Further, Levi is known for its Jeans, products which are robust and able to last for an extended period. In the most recent quarter, Levi saw its revenue decline 6%, suggesting it is feeling the impact. This has the potential to cause negative sentiment should quarterly results continue to weaken.
Revisions
Seeking Alpha's revision rating is C-, with a poor EPS revision record. This suggests Management's guidance has generally been on the optimistic end, which we can see as being possible currently, with a good growth forecast in a year where many retailers are suggesting a decline will occur. This could cause negative price action should an initial growth period be changed to a decline.
Insider trading
Insider trading (Dataroma)
Finally, insiders are only selling stock, which to some is an indicator that performance will be weakening in the coming period, rather than outperforming. This does marry up with the weakening economic conditions and arguably unachievable Management guidance.
Final thoughts
Financially, Levi is an incredibly attractive business. The brand is being utilized to achieve impressive profitability levels while being partnered with healthy growth. Looking long-term, the company's expansion overseas and non-jean products are showing outsized growth which will help push the business forward. The key financial risks we see are around the achievability of FY23 forecasts and the large increase in inventory held.
Relative to Levi's peers, we think the business performs extremely well, suggesting it is one of the best brand-led retailers on a fundamental basis. The valuation underlying this is extremely attractive, suggesting a healthy upside.
Investors with a shorter time horizon or looking to time the bottom may do well by remaining patient, as a decline in quarterly earnings could drive the share price down.
For further details see:
Levi Strauss: Financially Superior Retailer