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Investment Thesis
Levi Strauss (NYSE:LEVI) delivered once again with a solid quarter and provided a strong guidance for the upcoming fiscal year despite the hostile macro environment. In this article, I highlight how the company’s bold strategy makes it well-positioned to succeed in a world of evolving consumer tastes and how, from a valuation standpoint, there is much to like about the company.
A Snapshot of Levi Strauss’ Q1 Performance
As mentioned earlier, LEVI announced its 1st quarter results and they were impressive. Revenue was up 26% year-over-year on a constant currency basis and diluted EPS came in at $0.46, which represents a year-over-year growth of 35%.
The jump in revenue could be attributed to the strong showing of its Direct-to-Consumer channel and its e-commerce channel, which saw sales jump 39% and 13% year-over-year respectively. The company also saw sales surging in its largest market, the U.S., with revenues growing at 24% year-over-year, its highest first quarter revenue for this market in over a decade. Europe and Asia also saw robust growth, with revenues jumping 13% and 11% year-over-year respectively.
With respect to outlook, the company provided a strong guidance for FY22 with revenues expected to come in between $6.4 to $6.5 billion, representing a growth of 11 to 13%, and adjusted EPS expected to come in somewhere between $1.50 and $1.56.
Circular 501 and Acquisition of Beyond Yoga: Proof of Levi Strauss’ Adaptability
As consumers become more and more environmentally conscious, retailers have been driven to manufacture their offerings using recycled materials. In line with this trend, LEVI, in January, launched the circular 501. The environment-friendly version of the iconic 501 is manufactured using organic cotton and is deigned to be recycled.
What is impressive with this development is that the company has not only chosen an iconic brand to go green but also it has chosen a jeans style that is currently trending. According to the NPD Group, straight leg jeans, which is the category where the 501 belongs, had a market share of 33% in 2021, compared to 29% in 2019. On the contrary, according to the same source, skinny jeans saw its market share drop from 41% in 2019 to 30% in 2021. Furthermore, the sales of the 501 were up 50% in the recently concluded quarter, in line with the trend. Therefore, the decision to give the iconic brand, which has been tremendously successful and which is helping the company to capitalize on the current consumer preferences, an eco-friendly makeover is a testament to the company’s adaptability.
The other major development that highlights the company’s adaptability is the acquisition of Beyond Yoga. The subsidiary, which is undergoing the final stages of integration, generated sales of $26 million in the recently concluded quarter, an impressive feat. What is exciting about the acquisition is how it would help the company to tackle the huge addressable market of the yoga clothing market, something that even the management touched upon during the earnings call. According to Fortune Business Insights, the yoga clothing market is expected to grow at a CAGR of 8.4% to $39.91 billion by 2028.
While Beyond Yoga caters to the premium yoga apparel market and while the yoga industry’s growth in the near term could take a hit as consumers start spending more time outdoors, the addressable market must not be underestimated. Furthermore, as the obsession with Athleisure continues to remain high, the acquisition of Beyond Yoga is proof that LEVI can adapt to the ever-changing fashion trends and shows that the company is more than capable of diversifying away from its jeans business.
Negligible Exposure to Geopolitical Risk is a Blessing
Unlike Nike, Levi Strauss does not have a China problem. Only 5% of the company’s global production is attributed to China, with most of it produced for the Chinese market. Furthermore, China accounts for less than 3% of the total global business. Thus, LEVI is well-shielded from the Covid lockdowns in the country.
Furthermore, the company has effectively shielded itself from the surging prices in cotton, a by-product of the Russia-Ukraine war. The management only sees a 5% year-over-year growth in cost of goods sold as a result of the rising cotton prices and till date, such inflationary pressures have been mitigated to a large extent by the company through price hikes. AURs, for instance, which represent the average selling price of an item, were up by 10% during the recently concluded quarter, with no negative impact on demand. Not only did this allow the company to tackle the inflationary pressures, but it also led to higher EBIT margins.
Finally, with respect to the direct impact of the Russia-Ukraine crisis, the impact is likely to be minimal in the coming quarters since Russia accounts for only 2% of the overall business for the company. Moreover, approximately 85% of the company’s European sales largely come from Western Europe, which further implies that the direct impact would not be damaging.
Valuation
The company is expected to earn between $1.50 and $1.56 for FY22. I adopted a conservative approach, given the hostile macro-environment that the company operates in, and assumed the lower figure of $1.50. The company’s 5-year historical median forward price to earnings multiple, according to Refinitiv, is 18.3x.
|
Forward Price/Earnings Multiple Approach |
|
|
Price Target |
$27.50 |
|
5-year Historical Forward P/E Multiple |
18.3x |
|
Projected FY22 EPS |
$1.50 |
Source: Refinitiv and FY22Q1 Earnings Call
If I apply this multiple to the EPS of $1.50, this will result in a price target of $27.50, which represents an upside of approximately 47% to the closing price on 12th April 2022.
Risk Factors
The major risks facing the company are the currency headwinds, driven by a strong U.S. Dollar. The U.S. Dollar index is up 4% year-to-date and is hovering around levels of 100. With the Federal Reserve recently turning aggressively hawkish, there is a strong likelihood that the dollar would continue its upward trajectory, which would put pressure on the company’s earnings derived from outside the U.S. During the recently concluded earnings call, the management suggested that currency headwinds are expected to drive down revenue and EPS by approximately $200 million and $0.15 respectively. I wouldn’t be surprised if these estimates get worse in the coming quarters.
In addition, while the Russia-Ukraine crisis might not affect the company’s sales in those regions, a worsening war could still have an indirect impact on the company’s earnings, through higher prices of commodities in general, and cotton, in particular. Cotton prices are expected to jump to $146.85/lbs according to Trading Economics, which represents an upside of nearly 10%. While the company continues to negotiate with suppliers, any failure to reach an agreement could have an adverse impact on its COGS, which would drive the company to raise prices.
Levi Strauss has so far successfully raised its prices without adversely affecting its demand. But the company’s ability to keep raising prices is likely to hit a ceiling at some point in the future. The impact of higher cotton prices and its subsequent impact on the company’s COGS is, therefore, a risk factor that needs to be seriously considered.
Concluding Thoughts
Levi Strauss has been impressive lately. It has done a fantastic job navigating a hostile macro environment and has also adapted to the ever-changing consumer tastes brilliantly. Products such as the Circular 501 are testament to that. From a valuation standpoint, the stock looks cheap, with a potential upside of close to 47%, on the basis of its historical forward P/E multiple.
Although we live today in a treacherous, volatile market environment, and while there are risks such as strong currency headwinds facing Levi Strauss, I would be comfortable being in this stock as much as I would be in one of the company’s jeans.
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