After Share Price Correction, Levi Strauss Is Now A Strong Buy
- We believe shares of Levi are now in 'Strong Buy' territory, with a very compelling valuation and the impacts from the Covid crisis mostly behind.
- LEVI stock looks attractive at a ~11x forward price/earnings ratio, and a dividend yield approaching 2%.
- Levi Strauss is also repurchasing shares and doing strategic acquisitions like that of Beyond Yoga.
- Profit margins and the balance sheet are strong, and Levi is guiding for high revenue growth for fiscal year 2022.
We've been following Levi Strauss (NYSE:LEVI) for a while looking for a good entry price, and we believe shares are getting close. While not as cheap as it got during the depths of the Covid crisis, the situation today is much more stable and the company is not at significant risk of bankruptcy.
Since its IPO in 2019 shares have gone as high as $30.48 and as low as $9.51, and are currently trading not far from the initial public offering price of $17 (although shares opened at $22.22 for the public). By the way, this was the second time the company went public, the first time was 1971, but then went private for several decades.
In any case, we believe current prices have become attractive, with the company's profitability benefiting from some of the measures it took during the pandemic. Such as cutting 15% of its corporate workforce after sales dropped due to the coronavirus lock-downs. The cut of ~700 office jobs didn't affect employees at stores or factories, and was estimated to save the company ~$100 million a year. Those measures are still having a positive impact on margins and profits at the company as we'll see when we get into the financials of the company.
Why Levi, Why Now
While shares have been lower before, we do not believe they have been cheaper, since the company is a lot more profitable now, and the prices during the lows of 2020 came with incredible uncertainty and the company could potentially have gone bankrupt.
Now shares are a little bit higher, but sales are up 11% versus pre-pandemic levels of two years ago. And we see all of the following tailwinds benefiting the shares going forward:
Increasing margins: Beyond Yoga is guided to be accretive to margins, plus the company has been aggressively raising prices. It noted that its brand equity has never been stronger, and that has enabled the company to raise average selling prices by 10% without negatively affecting demand. These decisions are instructed by powerful proprietary technology and analytics, including artificial intelligence and methodical analysis of price elasticity.
New product innovations: The company continues to innovate and launch new products, a good example is the premium-priced circular 501, a new version of the 501 original made with organic cotton.
Direct to consumer accelerating: The Levi's app continues to show positive results with monthly active users more than doubling in the quarter as well as increase in traffic and conversion across the US and Europe. In Q2, the app will be rolled out to India and several European countries with further expansion later in the year.
Partnerships expanding: Based on the overwhelming success of the Levi's brand at Target, they decided to expand their partnership together taking the brand further than either of the companies thought possible back in 2019. Back then the goal was 500 doors, but as the results have been so strong, they will be rolling out to an additional 300 stores this Spring.
Levi Strauss' Financials
Thanks to the cost cutting and other operational improvements the company has made, gross margins are considerably higher, as well as operating margins, which are benefiting also from increased sales and operating leverage.
Revenue growth went significantly negative during the worst part of the Covid crisis, and then significantly positive during the recovery. On average, since the company went public, revenue has grown at a 9.5% average.
The company has a very strong balance sheet with almost as much cash on hand as gross debt. Total liquidity at the end of fiscal 2021 was $1.7 billion, which gives the company a lot of flexibility to execute its various strategies.
The company is using this flexibility it gets from its strong balance sheet to do several things. It is reinvesting for growth in CapEx, it is returning capital to shareholders through dividends and buybacks, and made some acquisitions like Beyond Yoga.
Beyond Yoga is an interesting acquisition since it will give the company a presence in the fast-growing active-wear segment with a brand with tremendous growth potential. It is expected to bring ~$100 million in sales in fiscal year 2022, and to be immediately accretive to margins and earnings per share. Some more interesting data points about this acquisition are included in the info-graphic below:
Impact Of Inflation
As with most business right now, inflation is a big concern, but thankfully it seems the company has been managing to pass the cost to customers, and that this price increases are sticking. During the Q&A session of the last earnings call, this is part to what CEO Chip Bergh responded to an analyst's question on pricing:
So the business is very, very healthy, and we feel good about the consumer and we do believe that there is still opportunity for more pricing down the road in the second half of the year, which we think we're going to need based on where costs are going and we've been extremely surgical with how we've done our price increases and I think that's a big part of the reason why it's been sticking.
LEVI Stock's Current Valuation Presents A Solid Opportunity With Margin Of Safety
Now we get to the fun part of analyzing the valuation. As can be seen below with the EV/EBITDA ratios of Levi's and some competitors, the company appears cheap, but some competitors look even cheaper. Still, we believe the premium is warranted given the good management of the company, the strength of the brand, and the expected revenue growth.
The forward price/earnings ratio is cheap at ~11x, certainly much cheaper than the average P/E ratio the company has had since its IPO in 2019. The company also pays an attractive dividend which is now approaching a 2% dividend yield. The dividend should be relatively safe considering the low payout ratio of ~21%.
We believe investors are getting a great deal at current prices, below we share our discounted cash flow model with the following assumptions: earnings based on analyst estimates for the next three years, 9% growth thereafter (around the historical revenue growth figure) until 2030, 2% terminal growth, and a 10% discount rate. With this model, we get an intrinsic value price of $28.30, which is almost twice the current price at which shares are trading. Using this model, we have to increase the discount rate to ~16% to get close to the current share price. We, therefore, believe now is a good time to buy, and that there is a good margin of safety embedded in the current share price.
|EPS||Discounted @ 10%|
|Terminal Value @ 2% terminal growth||40.46||15.60|
For fiscal year 2022, the company is guiding for a 11-13% growth in revenue versus the previous year, and earnings per share in the range of $1.50 to $1.56.
The Haas family controls the company through the company’s dual share structure. The family, through “Class B” stock, has 10 votes for every 1 vote of common “Class A” shares. We don't believe this to be a particularly important risk, but their interest might not always align with those of minority shareholders. For example, in case of a takeover offer they might decide to vote against it.
Another risk we see is that their website has been declining in ranking, which is more concerning given their increased efforts in direct to consumer [DTC] sales.
We believe shares of Levi's are now in 'Strong Buy' territory, with a very compelling valuation and the impacts from the Covid crisis mostly behind. Shares appear attractive to us at a ~11x forward price/earnings ratio, and a dividend yield approaching 2%. The company is also repurchasing shares and doing strategic acquisitions like that of Beyond Yoga. Profit margins and the balance sheet are strong, and the company is guiding for high revenue growth for fiscal year 2022. We believe shares are trading significantly below its intrinsic value based on our DCF model, we, therefore, consider them a strong buy.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in LEVI over 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.
The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling shares, you should do your own research and reach your own conclusion, or consult a financial advisor. Investing includes risks, including loss of principal.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.