Levi Strauss & Co Stock: The Recent Jump In Price May Be An Overreaction (NYSE:LEVI)

Levi Strauss & Co. (NYSE:LEVI) is a well-known brand all around the globe for their jeans and denim products. The firm has underperformed the broader market and also the consumer discretionary sector in the past twelve months, even though there has been a significant jump in the share price after the earnings results came in better than expected.

The aim of our article today will be to give a recap of the most important points from the earnings results, as well as to form expectations about the near future, taking micro- and macroeconomic considerations into account. We will also pay close attention to profitability and its development as well as to a set of valuation metrics, primarily focusing on a set of traditional price multiples. The ultimate question that we would like to answer, is whether LEVI’s stock could be an attractive investment at the current price level or not.

Earnings results

Sales

Let us start by looking at the top line results of the firm, which appear quite worrying at first sight. The firm has reported a sales decline of 8% compared to the same period in the prior year. However, it may not be as bad as it seems. Most of this decline can be explained by one time impacts, which we believe is not dictated by the consumer. These one-time impacts are:

• shift in wholesale shipments from Q2 to Q1 2023 from the U.S. ERP implementation
• impact of the exit of the Denizen business and Russia

If we exclude these two negative factors, net sales would have been flat compared to the prior year.

Also important to highlight here that these factors have been impacting different segments. The shift in wholesale shipments and the exit of the Denizen business have affected the Americas segment, while the exit from Russia has impacted the Europe segment.

The Asia segment has stayed stable, after exhibiting an impressive growth of 22% in the prior year.

Although we believe that the results are somewhat better than they first seem, they are not particularly impressive. There are little signs of growth across most markets, and based on the firm’s full year guidance, only a 1% to 3% revenue growth is anticipated for the full year.

On the other hand, the improving consumer confidence in the current year may provide tailwinds for LEVI’s business and the consumer discretionary sector in general. Consumer sentiment is often regarded as a leading economic indicator, which can be used to gauge potential changes in the spending behavior of the consumer in the near future. As the sentiment has significantly improved compared to the prior year, we believe people are likely to start spending more in discretionary, non-essential items towards the end of the year. The moderating inflation and the potential Fed rate cuts could further improve the confidence in the coming months.

Profitability

While we are not particularly impressed by the revenue figures and its development, even if we exclude the on-time negative impacts, we are somewhat more optimistic about the firm’s profitability. The gross margin in the prior quarter has reached as much as 58.2%, representing an expansion of 240 bps, compared to the prior year. This improvement has been driven by the lower product costs and the favourable shift in mix. On the other hand, the operating margin has declined substantially, but this is also a result of one-time charges. The decline from 9.3% to (0.03%) has been mainly driven by restructuring charges related to Project Fuel, which is aimed at cost savings. These charges totaled in $116 million, accounting for severance packages and post employment benefits. Further the EBIT margin has also declined, driven by the lower net revenues.

Now that we have seen the developments in the last quarter, let us take a look at the bigger picture. The following chart shows, how the firm’s profitability metrics have changed over the past years, and the following table compares LEVI’s figures with those of its peers from the industry.

Despite maintaining a relatively stable margin over the years, despite the macroeconomic headwinds, and even expanding these margin in the prior quarters, LEVI is still by far not the most attractive company in the industry from a profitability point of view.

The inventory levels have also moderated in the past quarter, which we believe is a positive sign, and may have a positive impact on the margins looking forward, as the likelihood of obsolescence or the need for discounting may be lower.

Valuation

To assess, whether the company could be an attractive investment option at the current price levels or not, we are going to take a look at a set of traditional price multiples. The following table compares LEVI’s metrics with its own historic averages and with those of the respective sector median.

While the stock appears to be trading at a discount compared to its own historic values, the firm seems to be overvalued compared to the sector median. As the sector may be a too wide group, containing firms which have largely different businesses from LEVI’s, we decided to narrow down the peer group to selected firms from the industry.

We can also see a premium here across most metrics. And we believe that this premium is not justified, for the following reasons:

1. the profitability and the growth metrics are not outstandingly good compared to the rest of the industry

2. while the firm is working hard to implement cost saving measures, we would like to see their real impact, before we could get more bullish

3. the firm has significant debt in its capital structure, which may need to be refinanced, while the interest rates are still high.

For these reasons, we do not believe that the significant jump in price is entirely justified and therefore we cannot assign the stock a buy rating right now. We have, however, written several articles on LEVI’s peers, which may be also of interest to you. These include:

The Pros And Cons Of Investing In Ralph Lauren Now

Lululemon: Why We Think The Selloff Provides An Opportunity

Key Takeaways From Victoria’s Secret Earnings

V.F. Corporation: The Reasons Why We Do Not Want To Own The Stock In 2024

Conclusion

The firm has beaten analyst estimates, both top- and bottom line, leading to a significant jump in the share price after the announcement of the results. The expected growth and the anticipated expansion of the margins have also contributed significantly to the positive reaction.

In our opinion, the recent increase may not be fully justified. Though we expect the macroeconomic environment to improve, the uncertainty about how it will impact the demand for LEVI’s products remains high.

The results of the firm’s cost saving initiatives is also yet to be seen.

Overall, the growth and the profitability of the firm within the industry is not outstanding, while its valuation metrics are relatively high.

For these reasons, we cannot assign a buy rating to the firm’s stock.

We rate LEVI’s stock as “hold”.