Levi's IPO: Fantastic Business, But Expensive At 7.7x Forward EBITDA

|
About: Levi Strauss & Co. (LEVI)
by: Wilsonville Capital
Summary

Levi designs and markets casual and dress pants, jeans, tops, shorts, skirts, jackets and any other related accessories for men, women, and children.

Almost 100% of its manufacturing facilities are located outside the United States. As shown in the table below, Levi runs its manufacturing facilities in Poland and South Africa.

The Trump administration could harm the operations of Levi. The imposition of higher tariffs on imports into the United States may create a reduction in gross profit margins.

Adjusted EBITDA increased by 16%, 3.9% and 0.3% in 2018, 2017, and 2016. In the year ended November 2018, EBITDA was equal to $706 million. With these figures in mind, assuming forward EBITDA of $776 million seems very reasonable.

Levi reports a Debt/EBITDA ratio of 1.35x. The company has much more leverage than other peers.

Following our report about Levi (LEVI), which investors should read, there is an assessment of the share price in this article. The company is trying to sell shares at 7.7x EBITDA, which seems a bit expensive. While other competitors with similar EBITDA margins are trading at 7x, 8x and 9x EBITDA, Levi should not do so. The company’s leverage seems larger than that of most of its competitors, which should be pushing the valuation down.

The debt does not represent a serious trouble as it is payable with effect from 2025. However, investors should take into account the financial risks in the valuation of the shares. Having mentioned these features, the company expects to have a dual class stock, which does not help. In addition, it is not ideal either that certain existing shareholders are expected to sell shares in the IPO.

Source: Prospectus

Business And Operating Risks

Headquartered in San Francisco in 1853, Levi designs and markets casual and dress pants, jeans, tops, shorts, skirts, jackets and any other related accessories for men, women, and children.

The company does not need a lot of presentations as the brand is very well-known and very old. Note that the founders of Levi were responsible for the invention of the jean in 1873. Due to these reasons, Levi should not have a lot of problems while presenting its business in the new IPO.

The company sells all over the world, but its largest market segment in terms of net revenues in fiscal year 2018 was Americas with 55% revenues. Europe represents 29% of the total amount of revenue and Asia accounts for 16% revenues.

In 2018, Levi sourced approximately 99% of its products from independent contract manufacturers. Many of them seem to be outside the United States. In addition, almost 100% of its manufacturing facilities are located outside the United States. As shown in the table below, Levi runs its manufacturing facilities in Poland and South Africa:

Source: Prospectus

With the manufacturing facilities outside the United States, investors should understand clearly that the Trump administration could harm the operations of Levi. The imposition of higher tariffs on imports into the United States may create a reduction in the gross profit margins and reduce the company’s business. The company provided the lines below in this regard:

Source: Prospectus

Balance Sheet

Levi’s financial situation seems very stable with $3.54 million in total assets and $2.6 million in total liabilities. In addition, prior to the IPO, the company presents a massive amount of cash, which amounted to $0.713 billion.

With finished goods of $0.877 billion, investors should be expecting more cash in the near future as the amount of inventory is distributed. The image below provides the list of assets:

Source: Prospectus

The amount of financial debt is not small. The long-term debt equals $1.02 billion. However, with $0.713 billion in cash and EBITDA of more than $700 million, it should not worry investors. The image below provides the list of liabilities:

Source: Prospectus

Expected Capitalization And Valuation

As shown in the image below, the company is old, but it has been able to maintain a high Adjusted EBITDA margin. On November 25, 2018, this figure was equal to 10.5%. It is quite beneficial that the margin has not moved below 10% in the last four years.

Source: Prospectus

Please note that the company has been making a lot of efforts to push its EBITDA up. Levi invested in restructuring expenses in the last four years. The image below provides further detail on this matter:

Source: Prospectus

Adjusted EBITDA increased by 16%, 3.9% and 0.3% in 2018, 2017, and 2016. In the year ended November 2018, the EBITDA was equal to $706 million. With these figures in mind, assuming forward EBITDA of $776 million seems very reasonable.

The number of shares outstanding after the IPO is expected to be approximately 385.4 million. At $15 per share, the expected market capitalization should be 5.781 billion. Please note that the company expects to sell class A shares and there will also be class B shares with 10 times more voting power than class A shares. This is not ideal. The image below provides further details on this matter:

Source: Prospectus

Source: Prospectus

Assuming $819 million in cash and debt of 1.052 billion, the expected enterprise value should be equal to $6.01 billion. The expected capitalization is shown in the image below:

Source: Prospectus

With Forward EBITDA of $776 million, the company should be trading at 7.7x Forward EBITDA. The company’s competitors, mentioned in the prospectus, are the following: Abercrombie & Fitch Co. (ANF), American Eagle Outfitters (AEO), Ascena Retail Group Inc. (ASNA), Burberry Group PLC (OTCPK:BBRYF), Carter's Inc. (CRI), Clorox (CLX), Columbia Sportswear (COLM), Dillard's (DDS), Foot Locker (FL), Gap (GPS), Guess (GES), and Ralph Lauren Corp. (RL). As shown in the image below, these companies trade at 3x-17x EBITDA:

Source: YCharts

Having mentioned the EV/EBITDA ratio, not all these companies report the same amount of debt. Most of them show a Debt/EBITDA ratio of 0-1.9x. Levi reports a ratio of 1.35x, which means that the company has much more leverage than other peers. The image below provides further details on this matter:

Source: YCharts

The company’s EBITDA margin of 10.5% is not better than that of competitors. Most of them report an EBITDA margin of more than 11%. The image below provides further details on this matter:

Source: YCharts

With all these figures in mind, the company seems a bit expensive at 7.7x EBITDA. While Levi’s EBITDA margin is approximately the same as that of other competitors trading at 7-10x EBITDA, Levi’s debt/EBITDA ratio is larger than that of other competitors. Because of these reasons, value investors may wait to buy the company at 4x-6x EBITDA, which seems much more attractive.

As mentioned in the previous report, Levi does not seem to have a significant amount of debt. It should be able to pay the debt. In addition, the payment is due in 2025, 2026, and 2027. Here is what Wilsonville Capital said in the previous article about Levi:

“Levi will need to pay its debt in 2025 and 2027, and it is paying rates of 5% and 3.375%, which should not worry most investors. With this information in mind, as of February 17, 2019, the risk of bankruptcy is non-existent.” Source: Seeking Alpha

There are other reasons to believe that the price of the share should not be $15. As shown in the lines below, the Board of Directors expects to be independent. However, a family owns a large amount of voting power and may block transactions to unlock shareholder value. This feature should not be appreciated by minority shareholders.

Source: Prospectus

On top of it, it is not beneficial that certain shareholders are expected to sell shares in the IPO. The amount of shares being sold is not small. Take a look at it in the image below:

Source: Prospectus

Conclusion

Selling shares at 7.7x Forward EBITDA, the company does not seem that interesting. The main reason is that there are peers trading with less valuation, better EBITDA margins and less leverage. In addition, the fact that several shareholders are expected to sell equity in the IPO is not helping. Finally, the existence of class A shares and class B shares should represent an issue to value investors.

Having said this, Levi is a brilliant business and it should be bought at 4-6x Forward EBITDA. Keep in mind that the company is making a lot of efforts to push its EBITDA up. On top of it, if the company is able to reduce its leverage, its EV/EBITDA should increase. For these reasons, it is a name to be followed closely after the IPO.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.