Levi Strauss Stock: Risks Ahead In Growth Strategy (NYSE:LEVI)

Investment Thesis

Levi Strauss & Co (NYSE:LEVI) is an apparel company in the process of strengthening its brand over the next five years. The company’s strategic focus on brand expansion, bolstering direct-to-customer sales, and diversifying its product lines shows promise for achieving ambitious 2027 targets. However, while positioned for growth, the stock’s valuation appears relatively high within its peer group. When we consider the macroeconomic risks, potential challenges with debt management, and the uncertainty of new market ventures, I believe investors should take a cautious, wait-and-see approach. In this article, I’ll delve into the particulars of Levi Strauss’ strategy and unpack the risks I see going forward.

Company Overview

Levi Strauss & Co. needs no introduction. Most famous for their jeans, they also design and manufacture casual wear and other accessories for both men and women globally. As one of the largest apparel companies in the world, with brands such as Levi’s, Dockers, Signature by Levi Strauss & Co., Denizen, and Beyond Yoga, the company has operations in more than 110 countries. The company has many different channels it sells through, including wholesale, e-commerce, shop-in-shops, and DTC sales through a network of over 3100 company owned and operated stores.

Rather than go by business segment, I think it’s helpful to explore the breadth of its casual wear by type (denim, khaki, and yoga) to get a better understanding of the business. With jeans being what the company is most famous for, Levi Strauss’ denim line encompasses the majority of the products they sell. But it’s not only jeans. It also sells denim jackets and denim products through the Levi’s, Signature by Levi Strauss & Co., and Denizen brands. For the khaki lineup, this is mostly covered by the Dockers brand, which sells everything from khaki pants and shirts to jackets and shoes. the Dockers brand also does over half of the company’s total sales. Finally, Levi Strauss also got into the yoga space in 2021 with the acquisition of Beyond Yoga. While only bringing in a little over $100 million in revenue annually, this is a faster growing and high-margin market. It also diversifies the company’s revenues and opens up new avenues for long-term growth to resonate with younger generations like millennials.

Business Strategy

In 2022, Levi Strauss laid out a five-year plan for the company’s business strategy until 2027. This included the following targets:

• A revenue target between $9-10 billion (including annual growth of 6-8% organically, expanding DTC to 55% of total revenue, 3x ecommerce sales)
• An adjusted EBIT margin of 15%
• A ROIC ratio of 23%+
• Adjusted EPS of $2.70

These are ambitious targets, but the company thinks it can achieve these given their strategy of expanding through (1) brand led growth, (2) strengthening direct to customer (DTC) sales, and (3) diversifying its brand portfolio.

Expanding brand led growth

The global jeans market is expected to grow at a CAGR of 5.8% from 2023 to 2030. As the dominant market player, Levi Strauss has a unique position of having the most brand value, recognizable across the globe. It’s for this reason that the company views Levi’s brand as their most prized asset, given its interconnectedness across different business lines and its foothold in the apparel market. Over time, this brand growth has been steady, but the company wants to invest in the brand further through advertising campaigns that resonate with its customer base to capture more market share, focusing more on women and more on younger generations.

Strengthening DTC

DTC is a growing trend globally among brands, as it limits the reliance on physical stores. Through investing in DTC, this will enable the company to reduce overhead and capture better margins. For its 2027 target, the company wants to expand DTC from the sub-40% range to 55% in the next five years. While a physical store presence is still important and these won’t be shut down, the pandemic has highlighted the need to connect brand messaging with product availability and online channels like e-commerce are a great way to do this. In my view, these e-commerce initiatives like loyalty programs and personalizing product recommendations to customers can significantly enhance customer engagement, as they offer a more tailored shopping experience.

Diversifying Brand Portfolio

For diversification, Levi Strauss believes it can diversify further across its business lines, channels, and geographies and see more room in underserved areas for the company to grow. Particularly in the female segment, there’s significant opportunity to grow this market and focus in on brand messaging and develop more products for women. With the acquisition of Beyond Yoga, the company can expand further expand into the women’s and activewear market, something I view as key to growing the top line over its 5-year strategy.

Financials

When looking at Levi Strauss’ financials, the company reported third quarter revenues in line with last year but saw 14% growth in global DTC. Overall, much of the reason for the flatness in overall revenues was because of North America and Europe, but Asia and Latin America.

Even though this may have been a pretty lack-luster quarter, I think the results really highlight the points made earlier about diversification, as the ‘Other Brands’ segment was up 12%, driven by 9% growth in Dockers and 25% in Beyond Yoga. We’re also starting to see good growth internationally as Asia was up 12% year-over-year for the quarter while the Americas and Europe were down 5% and 2%, respectively.

A good example of this is the growth the company is seeing in India. On the earnings call, management mentioned that revenues from India have increased by almost 50% compared to pre-pandemic. I view this as a testament to Levi’s strategy of diversifying the company and opportunity available to the company internationally, especially in higher growth markets like India.

With respect to the company’s e-commerce initiatives, we can see evidence of this working with an acceleration in growth rate, with 18% growth in Q3 on top of 16% growth last year. In the US, DTC was up 10% (also up in every region) while wholesale was down, so there’s definitely been a shift here for the company. One of the main reasons wholesale was down was that summer had been pretty hot and didn’t have the same assortment of tops and bottoms that DTC does. Since the wholesale business is mostly just jeans, and most people don’t usually shop for jeans in summer, the wholesale business was negatively impacted. So in my view it shouldn’t be interpreted that the DTC business is cannibalizing revenues from the wholesale business.

Moving over to the balance sheet, Levi Strauss had $295 million of cash on its books with about $1 billion of long-term debt. At present, the company has a Debt to Equity ratio of 1.1x and a Net Debt to EBITDA ratio of 2.8x, so the company looks to be in a solid financial position with moderate leverage.

Valuation

Based on the 8 equity research analysts with one year price targets for Levi Strauss, the average price target is $16.00, with a high estimate of $19.00 and a low estimate of $14.00. From the average, this suggests about 2.6% downside, suggesting analysts are pretty constructive on the company’s stock.

Based on the comparable companies analysis below, Levi Strauss is trading at the higher end of its peer group and above the median and average on both and EV/EBITDA and P/E basis. At 8.9x EV/EBITDA, this might not look expensive, but consider that this is a low-growth retailer with a heavy capex spend going forward to implement its strategy. Investing for growth is not free.

When it comes to the company’s valuation, there are a few key risks I feel are worth noting. Firstly, Levi Strauss is a retailer, meaning that it lacks pricing power in the market and is more or less forced to compete based on market prices for its products. While it does have a superior brand, enabling it to charge a bit more, the costs associated with materials (like cotton for example) mean that controlling margins can be particularly difficult. Cotton prices are notoriously volatile and depend of many variables like weather, supply condition, energy price, and more.

Secondly, whether or not you believe we are heading into a potential recession, I think the macroeconomic environment looks challenging for retailers. Levi Strauss is exposed to interest rate risk on its debt (for which it will have to refinance at higher rates) and is also exposed to the consumer, which could also be impacted in an economic downtown.

Lastly, even for being a well-known and recognizable brand, there is a risk that the new types of products Levi Strauss introduces don’t work out, especially in the new market they open up in. In the international market especially, it will be important to monitor how its new lineups resonate with consumers in these regions. For me, I’d take a wait and see approach and watch for a few more quarters before we get confirmation that this part of the strategy is working.

Conclusion

Levi Strauss is a fantastic brand and I believe the company is taking the right steps to position the company for growth going forward. By expanding brand led growth, strengthening DTC, and diversifying its brand portfolio, the company has a decent chance to hit its 2027 targets five years out. However, trading at the higher end of its peer group valuation, shares don’t look cheap to me. With macro risks such as a deterioration in consumer confidence and consumer spending, the company could also face its own challenges with its debt load amidst higher interest rates and the possibility that its expansion and diversification is unsuccessful. Investors should also consider that investing for growth is not free and that capex is likely to increase. So far, things seem to be working out, but I would wait for a few more quarters before concluding that Levi Strauss’s strategy is sustainable and yielding consistent results. For now, I’ll be on the sidelines.