Levi Strauss & Co. (LEVI, Financial) released earnings on Thursday, and while the numbers looked good compared to estimates, the guidance was not what analysts wanted to hear. The stock was down about 16% as a result. However, I think the guidance was strong enough given the difficult economic situation. Levi also has a lot going for it, so I believe the selloff represents a potential value opportunity.
A look through the quarterly numbers
Personally, I thought the company's numbers were pretty solid for the first quarter of fiscal 2023. Revenue grew 6.3% year over year, coming in at $1.69 billion and beating estimates by $80 million. Non-GAAP earnings per share were $0.34, beating estimates by $0.01 but declining from the year-ago quarter. A key to the growth was in the Direct-to-Consumer (DTC) segment, where sales were up 12%. The company also reaffirmed expectations for the year for revenue between $6.3 billion and $6.4 billion and adjusted diluted earnings per share of $1.30 to $1.40.
For a business that was founded in 1853 and still maintains a solid GuruFocus financial strength rating of 6 out of 10, I think Levi has very little chance of closing up shop. However, the market didn’t like the contraction of gross margins from 59.4% in the first quarter of last year down to 55.8% in its latest quarter. Even with lower net income and increased inventories, I think the stock got unfairly punished. Shares are now trading below their IPO price of $17.
Levi Strauss has major brand value
Consistently ranked among the world’s most reputable companies, Levi is a story stock. It was founded by Levi Strauss, who immigrated to the United States from Bavaria in 1847. Strauss and his partner, Jacob Davis, invented the first blue jeans in 1873 by adding metal rivets to the pockets and waistband of denim pants, creating a durable garment for miners and laborers. Today, the company operates in over 110 countries and sells products through various channels, including wholesale, retail and online. Levi's brand portfolio includes Levi's, Dockers, Denizen and Signature by Levi Strauss & Co. The company's flagship jeans have had a renaissance in recent years, a big reason for the stock's re-emergence to the public markets.
The curent CEO, Chip Bergh, has been instrumental in this with a four part strategy that started with an advertising slogan - "Live in Levi’s." Creating a new tagline wasn't enough for the company; it required a new strategy, which became Chip’s top priority during his first year. The company outlines its strategy as follows:
"1. Strengthen our profitable core, which accounted for 80% of cash flow and profits from men's bottoms and sales in the top five countries and 10 wholesale customers...
2. Expand into new markets, such as women's clothing and developing countries like Brazil, Russia, India and China, where Levi’s had low market share and sales of tops were low...
3. Become a leading omni-channel retailer by improving our brand's consistency in our its retail stores and online...
4. Achieve operational excellence by cutting costs, driving cash flow and becoming more data-driven and financially disciplined."
The other big investment in change came in 2013, when the company bought the naming rights to Levi’s Stadium, the new home of the National Football League's San Francisco 49ers. This is a 20-year, $220 million deal with an option to extend to 25 years. Looking back with inflation and how valuable the NFL remains, it was a good deal, though investors may overlook this part of Levi's business.
Financially rock solid
Levi only recently went public again in 2019 after it had remained private for over three decades after being previously publicly traded from 1971 to 1985. In 1985 it was taken private in a leveraged buyout by descendants of the founder, the Haas family. Some of that leverage has been paid down, with long-term debt shrinking from $1.5 billion to $984 million. More importantly, growth in revenue, profit and retained earnings has continued to increase the value of the brand.
Over the long term, revenue has grown from $4.6 billion to $6.1 billion in the last decade. Net income more than doubled from $229 million to $569 million in the same time. Meanwhile, retained earnings nearly quadrupled from $476 million to $1.7 billion. Keep in mind, for most of the decade Levi Strauss was a privately held business and didn’t need to focus on growth in the same way. Going forward, I’d be shocked if it couldn’t achieve double digit annual growth in earnings per share with some regularity, whether revenue rises at a similar rate or not.
With all of these strengths, I think the stock is a bargain at a forward price-earnings ratio of just 11. There seems to be a lot of upside potential still left for the company. It hasn’t even really touched social media yet. It has the money to figure that out and if it does, watch out - growth could accelerate.
