Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
This morning, as procrastinating taxpayers were scrambling to get their tax forms in the mail, Wall Street began weighing in on the recently public Levi Strauss. So far, of the dozen Wall Street firms that underwrote Levi's IPO, about half have published ratings on the stock, according to a rundown by TheFly.com. Four of the firms that have weighed in rate Levi Strauss stock a buy (or equivalent rating), while three more rate the stock only hold, neutral, or something similar.
Here's what they have to say.
These analysts think Levi's are cool
Let's start with the good news. So far, JPMorgan Chase, Citigroup, Guggenheim Securities, and Telsey Advisory Group have all chimed in with buy ratings on Levi Strauss.
Of these four, arguably the most important endorsement comes from JPMorgan, which underwrote 10.8 million shares of Levi Strauss sold during the IPO -- more than 10 times the number of shares underwritten by the other three firms rating Levi buy combined.
JPMorgan praises Levi's "strong tenured management team" and argues that the company's brand heritage offers it a competitive advantage over its rivals in jeans. The banker assigns a $26 price target promising about 13% upside from Levi's current $23-per-share price.
Guggenheim likewise values Levi as $26 a share.
Citigroup, the second-most-recognizable name endorsing Levi's today, thinks the stock could go up to $27 a share. Levi's has shown "strong" momentum in recent years, argues the analyst, and is likely to focus on sales of women's wear and tops, and expand sales into China, in order to grow its earnings in the high-single to low-double digits over the next few years.
Telsey tallies Levi's value at $28 per share.
Bored by blue jeans
So that's the good news. The bad news is that three of Levi's underwriters announcing ratings that seem to suggest that the stock has run up about as high as it's going to go already. That's not too surprising -- after all, Levi went public at $17 a share, and is already up 35% in three weeks. Valued at $9 billion in market cap (and with an additional $0.3 billion in net debt, raising its enterprise value to $9.3 billion), the stock has already had a pretty good run.
Recognizing this, Morgan Stanley observes that the market has been "enthusiastic" in buying the stock. Although Morgan Stanley continues to see "compelling" opportunities for Levi to grow its direct-to-consumer and international businesses, and to expand its offerings into new categories, the best rating Morgan Stanley can give Levi Strauss stock at this point is equal weight. The analyst says $23 a share is already just about the right price.
Merrill Lynch likewise cites a high valuation as its reason for giving Levi stock a neutral rating (albeit the analyst says Levi could conceivably go up a bit more, perhaps to $25 a share).
But it's Goldman Sachs' note that should perhaps worry Levi Strauss shareholders most of all. At 17.2 million shares sold, Goldman was far and away the biggest backer of Levi's IPO. Yet in today's comments, Goldman takes the most pessimistic position of any of the analysts named so far. Although Goldman agrees with JPMorgan's assessment that Levi has the potential to show "superior" growth rates, Goldman nonetheless believes that these prospects are already reflected by the stock's current valuation.
Indeed, in Goldman's view, Levi Strauss is probably worth only about $21 a share.
What it means to investors
Granted, even $21 a share works out to a 23.5% gain for investors who got in on Levi Strauss's IPO at its offer price -- a very respectable profit. But for anyone who owns the stock at today's price, Goldman's assessment equates to a warning that it's now overpriced.
I think they should take that warning to heart.
Here's why. At $9 billion in market cap, Levi stock costs more than 20 times trailing earnings. That's already a high price to pay if we assume that Citigroup is right about Levi growing in the high-single- to low-double-digit range -- and remember that Citi is one of the analysts rating Levi stock a buy. Levi's valuation looks even more stretched when you notice that the $449 million in trailing earnings that that P/E is based on overstates actual cash profits at the company. According to data from S&P Global Market Intelligence, Levi's cash from operations last year was only $410 million (9% less than reported earnings), while Levi's free cash flow was only $245 million -- 45% less than reported earnings.
Call me a pessimist if you like, but I think 20 times earnings, and more than 36 times free cash flow, is simply too much to pay for a company growing earnings at 10%, give or take. Levi stock has had its run -- but now the fun is done.