I have no doubt that this company is known by many or at least the products that they're selling.
The goal of this post is to analyze the company's fundamentals, lay down some assumptions about the future, and value the company as a whole.
Levi's has been around since the 1850s, it has survived the World Wars, plenty of conflicts and scandals as well as the latest pandemic as a public company. Although it has existed for 170 years, it is public as of March 2019 (It has also been public between 1971 and 1985 before it was taken private again).
What is Levi's?
In a nutshell, it is one of the world's largest brand-name companies that designs, markets, and sells apparel. You'll notice that manufacturing and distribution are not included in the previous sentence.
That's because nearly all of the products are sourced & distributed through independent manufacturers. We can definitely debate whether having the manufacturing in-house is better or not, there are pros/cons to each option.
The DTC expansion
If you go through any of their latest quarterly/annual reports, investor presentations, or listen to an interview with their CEO, you'll notice that these three letters DTC appear very often. So, what is DTC and why is it so important?
DTC stands for direct to consumer and it's easiest to illustrate its importance through a simple example. If any of us buys a pair of Levi jeans through their eCommerce or through their retail store or through a third-party store, at the end of the transaction, we have the jeans and we've paid the cash. However, for Levi's, the transaction isn't the same. If the jeans are purchased through a 3rd party retailer, well, they'll get a small percentage of it (Otherwise why would they be selling the jeans in the first place?).
Back in 2011, only 20% of all the revenue came from DTC channels (Ecommerce and company-operated stores). This percentage increased to almost 40% in 2021 and the management is aiming for 60% by 2030.
The more sales they're able to shift to DTC, the higher their gross margin will be.
The financials
In the last 5 years (despite the pandemic), the revenue grew by 5% on average, ($4.9b in 2017 to $6.2b in the last twelve months). This percentage of course indicates the maturity of the company and it would be unreasonable for us to expect double-digit growth rates in the future.
In the same period, their gross profit margin increased from 52% to 58%! This really shows the brand behind the company. In difficult times, also with high inflation, a good brand is able to pass the prices to the final consumer. So far, Levi has been doing a great job in that aspect.
However, the operating expenses as % of revenue have increased, which is not ideal (42% in 2017 to 47% in the last twelve months).
Putting all of this together, we get to the operating margin that has improved from 10% to almost 12%.
The management's targets
The management is aiming for $9-10b in revenue by 2027, that's an annual growth rate of over 8%, way higher than what they delivered in the last 5 years. However, the company is not afraid to acquire other companies if they believe there's a good fit within their portfolio, so this increase in revenue doesn't have to come organically.
As for the margins, they're aiming for 60% gross margin and 15% operating margin. Part of this could be expected by their actions when it comes to the DTC expansion, but there's a lot of work to be done, especially when it comes to managing operating expenses.
The balance sheet
Levi's balance sheet looks quite clean and stable over time, with the exception of inventory. The level of inventory has been between $850 and $900m for the last 4 years and recently it spiked up to $1.1b. What causes it? Based on the data available, inflation and increase in the price of cotton. However, it is something that's to be monitored. One way that management can distort numbers is by ordering higher quantities that they can actually sell. When that happens, they are able to negotiate lower prices per product that immediately improves the gross margin. However, if that is the case, they're also stuck with inventory that they cannot sell, which one can argue is worse.
My key assumptions & valuation
Now, only because the management has big targets, that doesn't mean we should incorporate them in our forecast and take them for granted. My assumptions are as follows:
Revenue: 5% growth for the next 5 years then slowly decreasing to 2.75%.
Operating margin: Slowly improve over time to 12.5%
Discount rate: 7.75% increasing to 8.01%
Based on those assumptions, the fair value is $7.9b ($20.03/share)
Current market cap is $7.55b ($19.02/share)
Note: I have taken into account the cash, debt, and deferred taxes on their balance sheet as well as the outstanding equity options.
What if my assumptions are significantly wrong?
Based on the assumptions above, the revenue will grow by 53% in 10 years and the operating margin will be 12.5%.
I am aware that my assumptions could be significantly wrong. So, let's take a look at how the value of the company (per share) will change based on different assumptions regarding the revenue 10 years from now and the operating margin:
| Revenue / Op. margin | 10% | 12.5% | 15% |
|---|---|---|---|
| 40% ($8.8b) | $14.9 | $18.8 | $22.7 |
| 53% ($9.5b) | $15.8 | $20.0 | $24.3 |
| 86% ($11.6b) | $18.2 | $23.3 | $28.4 |
| 100% ($12.5b) | $18.9 | $24.3 | $29.8 |
The intersection of the 3rd row (86% revenue growth) and the 3rd column (15% operating margin) is what the management is aiming for. If they're able to deliver that, then the fair value of Levi's today is a bit over $28/share (A potential upside of over 40% compared to today's share price).
If they deliver the revenue growth without margin improvement or the other way around, the upside is a bit over 20%.
What are your thoughts on Levi as a company?
Also, feel free to provide feedback regarding the analysis, that is always appreciated!
Leave a Reply