Levi Strauss & Co. (LEVI) is a renowned clothing and footwear manufacturer and creator of the popular Levi. The company's product range includes jeans, activewear, footwear and accessories. Levi Strauss operates in more than 110 countries through a sales network of approximately 50,000 retail outlets and 3000 branded shops. The company's main geographical segments are North and South America, Europe and Asia.
What's the idea?
- The company's new growth strategy promises a good return to shareholders.
- Positive revenue dynamics and a strong balance sheet will allow investment in business expansion
Why do we like LEVI STRAUSS & CO?
Reason 1. Industry opportunities
At first glance, it may seem like such a brand may have modest growth potential, but in fact, the company has a lot to strive for. According to Euromonitor, the global denim market is expected to be worth $100 billion by 2022, while the apparel and accessories market is expected to be worth $1.6 trillion. Levi Strauss is expected to generate only $6 billion in revenue in the year to 2026. Additionally, the company estimates that the denim market will grow at a CAGR of 6% through 2026.
The company's management sees growth potential and, despite macroeconomic pressures, is building long-term development plans:
On 1 June, Levi Strauss unveiled a new strategy designed to take annual total shareholder return to levels above 10%-12% over the 2022-2027 horizon through:
- to increase revenue and margins
- buy-back programmes in conjunction with dividends
- supporting inorganic growth through mergers and acquisitions
The takeovers mentioned in the previous paragraph can already start in the short term due to several factors:
- negative macroeconomic environment has led to a decline in the value of many companies. As a result, there is an opportunity to acquire excellent assets at a discount
- Levi Strauss management sees an opportunity to revenue in the women's segment, which generate a third of its revenue in 2021 (which means that increasing the female customer base by diversifying the product offering will make it easier to revenue than continuing to focus more on the male audience).
The company expects revenue from the women's goods portfolio to grow at a compound annual growth rate of between 11% and 13% over the horizon to 2027, when the share of this segment will reach around 42%.
Additional diversification through acquisitions may also take place in the , footwear and accessories segments, as their share of revenue is significantly lower than that of (20% and 5% versus 75%, respectively).
Similar to the womenswear segment, the company's management plans to revenue in the segment with a CAGR in the range of 11%-13% until 2027.
Among other things, Levi Strauss is going to increase its presence in the online segment: in 2021, e-commerce under the company's management generated only 8% of revenue.
Management aims to increase revenue in this segment by $1bn by 2027. Once this goal is achieved, the average annual revenue growth rate over the planning horizon will be around 25%.
Another argument would be the company's desire to increase geographical diversification: at the end of 2021, half of its revenue was generated from the US market.
In this part, management plans to increase the share of international revenue to 53% by the end of this year and to 57% by the end of 2027. The CAGR for the international segment is estimated to be in the range of 8%-10%.
All of the company's plans listed above could potentially include plans for M&A deals, the conclusion of which on the short-term horizon would help bolster investor confidence in management's serious intentions and reflect positively on Levi Strauss' stock price.
Long-term potential is attractive because when the first successes of the strategy are achieved, the price of the company will reflect not only the growth rate already achieved by a certain timeframe, but also investors' expectations of continued positive trends.
Reason 2. Dividends and buy-back programme
Since the company's new strategy is focused on providing profits to shareholders, Levi Strauss is paying special attention to its dividend policy: management plans to maintain a dividend payout ratio in the range of 25%-35%. This means that, all other things being equal, if the company's revenue grows, the amount of dividends will increase proportionally. By buying the company's stock now at an attractive price, a better dividend yield can be obtained in the future. The company's dividend yield is currently around 3.2% per annum.
In addition, as of August 28, $724m remained in the buyback programme authorisation, which represents about 13% of the company's market capitalisation. The repurchase programme is not time-limited, but we expect management to focus on free cash flows and allocate the repurchase proceeds so that, together with the dividends, around 55%-65% of free cash flow will be returned to investors.
The company's results for the last 12 months:
TTM revenue: up from $5.47bn to $6.27bn
TTM operating profit: up from $638.9m to $766.5m
in terms of operating margins, up from 11.7% to 12.2%, mainly due to a decrease in the cost of revenue from 42.6% to 42%
TTM net profit: up from $457.2m to $571.5m
in terms of net margin we see an increase from 8.4% to 9.1%
Operating cash flow: decrease from $727.6 million to $448.8 million due to changes in working capital in other assets and liabilities
Free cash flow: down from $578.3m to $193.4m due to increased investment in new operations
Based on the results of the last reporting period ended 28 August 2022:
Revenue: up from $1.5bn to $1.52bn
Operating profit: down from $221.6m to $195.1m:
in terms of operating margin — decrease from 14.8% to 12.9% due to an increase in cost of revenue from 42.4% to 43.1% and an increase in SG&A expenses from 43% to 43.7%
Net income: down from $193.3 million to $173 million:
in terms of net margin, down from 12.9% to 11.4%
Operating cash flow: decrease from $250.8 million to $64.5 million mainly due to changes in working capital for other assets and liabilities.
Free cash flow: down from $209.9m to $11.8m due to increased investment in new operations.
Levi Strauss has shown good financial performance both in the last 12 months and in the most recent reporting period. However, Levi Strauss's free cash flow was in negative territory in the last quarter. We believe that this is a temporary phenomenon and that the company will be able to return to positive cash flows by the end of the next quarter due to customers for winter holidays, and in the future to increase them through the positive effect of new production facilities. In addition, the company still has sufficient cash and cash equivalents on its balance sheet so that there are no financial stability concerns.
- Cash and cash equivalents: $498.9 million
- Net debt: $372.4 million
- Net debt/EBITDA: 0.40x
Levi Strauss has a sufficiently low debt burden that leaves room for further expansion, including the company's use of debt capital.
It is worth noting that Levi Strauss trades at a slight discount to its peers on EV/EBITDA and P/E multiples.
For 2022, Levi Strauss management expects revenue growth in the range of 6.7%-7% (which corresponds to 11.5%-12% growth when adjusted for currency revaluation). In our view, the targets set are realistic and the revenue growth in a volatile environment demonstrates management's ability to manage the company competently, even in crisis conditions.
Ratings of other investment houses
The minimum price target set by Morgan Stanley is $16 per share. Bank of America, on the other hand, has set a target price of $32. According to the consensus, the fair value of the stock is $22.3, which implies a 43.71% upside potential.
- The macroeconomic situation could slow the company's growth by affecting product margins.
- If the company is unable to cope with cash-flow drawdowns, it is likely to reduce dividend yields