In late July, I wrote that Levi Strauss (NYSE:LEVI) stock was a tough buy, but the right buy. This was based on the idea that the clothing brand’s depressed first-half trends were going to inflect higher into the end of 2020. It appears this is already happening for LEVI stock. The company just reported third-quarter numbers, and they were miles better than what it reported in the second quarter.
In response, LEVI stock jumped. Shares have now soared as much as 42% since the late July low of $11.82.
It may be tempting to take profits here, and I would never fault anyone for locking in profits after such a sudden surge in just two months. But I think that Levi’s turnaround is far from over. In fact, it’s poised to run up to $20 over the next year.
Turnaround Has Already Started for LEVI Stock
With its third-quarter earnings report, Levi confirmed that its post-pandemic recovery has already started.
Revenues in the third quarter declined 27% year-over-year, much better than the 62% decline they posted in the second quarter. Significantly helping this recovery was a surge in e-commerce revenues, which rose 52% in the third quarter versus 25% growth in Q2.
On top of improving top-line trends, margins improved as well. Adjusted gross margins rose 60 basis points year-over-year — versus a 180 basis point contraction in the second quarter — and Levi actually netted a profit in the quarter (as opposed to its huge loss in Q2).
On the conference call, management was enthusiastic that these improving trends would persist into the fourth quarter and beyond. Indeed, Levi sees sales returning to post-pandemic levels by the second half of 2021.
If that happens, LEVI stock — which traded around $20 before the pandemic but currently trades about $15 — will stay in rally mode for the foreseeable future.
But is returning to pre-Covid-19 sales by late 2021 actually doable?
Zooming out, the bigger picture here is that the world is getting better at handling and managing the Covid-19 crisis without reverting back into “shutdown” mode.
Consumers are adapting to the pandemic — they are learning to wear masks when around other people, and they are getting better at social distancing. Many businesses are also adapting, moving their retail operations to open-air, outdoor settings like repurposed parking lots, streets and parks. Finally, legislators are becoming increasingly supportive of laws which focus on risk management, not risk avoidance.
And we will all only get better at this balancing act over the next few months, managing virus risks while sustaining quasi-normal economic and social behavior. As this progress builds momentum, consumer spending will rebound, especially discretionary consumer spending on things like clothes. Considering that consumer spending today is less than 6% below pre-Covid levels and continuing to rise, the base case here is for consumer spending — and consequently Levi revenues — to be back to “normal” by the second half of 2021.
Of course, that’s great news for LEVI stock.
Levi Is Continually Undervalued
Personally, I’m not a big bull on denim — I think the fashion trend will eventually move further into products like athleisure (yoga pants, spandex, etc). Still, I understand the staying power of denim in the fashion world, and by extension, Levi’s staying power as an important player in its market.
By my calculation, Levi has historically controlled about 0.3% of the global fashion apparel market for the past several years, with the company’s 2019 net revenues at $5.763 billion. That share will gradually shrink in coming years thanks to the likely pivot away from denim. But it should stabilize around 0.27% to 0.28%.
Assuming so, Levi Strauss projects as a low-single-digit revenue growth company after 2021, with room for profit margin expansion thanks to increased scale in the direct-to-consumer business, as well as a lower operating overhead due to a smaller physical retail footprint.
Under those assumptions, my modeling suggests that Levi could do about $1.50 in 2025 earnings per share. Based on a market-average 17-times forward earnings multiple, that implies a 2024 price target of over $25. Discounted back by 8.5% per year, that implies a 2021 price target for the stock of, again, nearly $20 — roughly where it traded before Covid-19.
Evidently, Levi is set to complete a full round trip back to pre-pandemic levels– and maintains some promise for the far future.
Levi isn’t necessarily a great long-term holding. But it is a stock that is materially undervalued today, ahead of a consumer spending recovery in 2021 which could completely eradicate that undervaluation.
To that end, the outlook for LEVI stock over the next 12 months is bullish. This stock has runway back to $20.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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