Blue jeans giant Levi Strauss (NYSE:LEVI) made its long-awaited return to Wall Street on Thursday, Mar. 21, and it was a smashing success. After reports that the IPO was seeing record demand, that record demand turned into a ton of buying. LEVI stock opened at $22.44, 32% above the $17 IPO price, and has largely held those gains in the first few hours of trading.
Despite the hype, I’m cautious on the Levi Strauss IPO. The fundamentals here aren’t great.
Namely, the jeans market is struggling thanks to the widespread adoption of athleisure styles. I don’t see that trend reversing course anytime soon. The numbers speak to these struggles. Levi Strauss has grown revenues at a rather tepid 2% compounded annual growth rate since 2011. Margins are moving higher, but not by much, and net profits have grown at just an 11% clip since 2011.
In other words, the story and numbers here aren’t great. Meanwhile, Levi Strauss now has a market cap of nearly $9 billion. Profits next year, in a realistic best-case scenario, will measure around $450 million. That means LEVI stock is trading at roughly 20-times forward earnings. The market average forward multiple is 16, and the average apparel retail forward price-to-earnings multiple is under 18.
In other words, with LEVI stock, you’re paying an above average multiple for what is a below average growth company. I don’t like that combination. As such, I’m fading the hype of the Levi Strauss IPO.
Levi Strauss Has Big Headwinds
The fundamental growth narrative behind LEVI stock isn’t all that great.
Over the past ten years, the apparel retail market has dramatically changed. At the core of this change is a secular consumer pivot towards healthier living. Due to things such as the widespread proliferation of photo and video sharing apps like Instagram and Snapchat, as well as a rise in health and wellness awareness, consumers globally are valuing health, wellness and fitness more than ever before. Being fit is cool. Eating well is cool. Working out is cool.
A big part of this pivot involves what consumers wear. The archetype of a trendy, healthy, and fit individual is someone who is wearing workout clothes from Lululemon (NASDAQ:LULU) or Nike (NYSE:NKE). As such, consumers have started wearing those clothes all the time now, both because consumers are working out more, and because they want to give the appearance of such.
What aren’t they wearing anymore? Blue jeans. Over the past decade, the blue jeans category has grown sales at a rather tepid 3.5% annual rate, slower than what has been reported across the whole apparel category. Thus, blue jeans have been losing share in the apparel market for a decade now, and that’s largely why Levi Strauss has been a mild 2% revenue grower since 2011.
This will continue. To be sure, Levi Strauss will still be a positive revenue grower. But, it will be a slow grower because this whole athleisure trend is as strong as it has been over the past decade, and only gaining momentum. Just look at the high single digit-plus growth rates at Nike, Lululemon and Adidas (OTCMKTS:ADDYY). So long as that trend remains on the up, Levi Strauss will remain on the down.
The down means slow revenue growth and mild margin expansion going forward. That’s not good enough to buy LEVI stock here.
The Stock Is Overpriced
At prices above $22 per share, LEVI stock looks overpriced considering fundamental challenges.
Those prices give Levi Strauss a market cap of nearly $9 billion. Assuming adjusted profits grow around 10% next year (as has been the norm over the past several years), then adjusted profits will be $460 million next year. Realistically, considering 2018 was a big up year, 2019’s growth will be relatively diluted against a tough lap. As such, a more realistic estimate for 2019 profits is $450 million.
That would give LEVI stock a realistic forward P/E multiple of 20. That’s too high.
Levi Strauss projects as a low single-digit revenue growth company over the next several years, with the risk of negative to flat revenue growth if the athleisure trend picks up more steam. Meanwhile, gross margins are improving, but operating margins aren’t growing by all that much, because the company is having to spend big on marketing to keep pace with more popular athleisure brands. These competitive pressures will continue, and put a lid on margin upside potential over the next several years.
All in all, even in a best-case scenario, I think Levi Strauss will do just $2 in earnings-per-share by fiscal 2025. Based on a retail average 18 forward multiple, that implies a fiscal 2024 price target for LEVI stock of $36. Discounted back by 10% per year, that equates to a fiscal 2019 price target of roughly $22.
That’s where LEVI stock trades today, implying limited upside over the next several months.
Bottom Line on LEVI Stock
Levi Strauss is a fine company, but all the IPO hype would make one think that there’s big growth around the corner. There’s not. Thanks to continued growth in the athleisure category, there’s simply more tepid growth around the corner. So long as that remains true, upside in LEVI stock looks limited from current levels.
As of this writing, Luke Lango was long NKE.