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...
Shares of jeans giant Levi Strauss & Co. (LEVI 0.80%) are trading below $17 today -- and below their $17 IPO price -- making this stock the very definition of a broken IPO.
That sounds like bad news, but the fact that Levi Strauss is down so much -- 30% below its post-IPO high in July, in fact -- has my fellow Fool.com contributor John Ballard thinking that now's the time to buy the stock.
And he's not alone.
Image source: Getty Images.
Upgrading Levi Strauss stock
This morning, analysts at investment megabank Merrill Lynch announced that they, too, are upgrading Levi Strauss stock.
Calling Levi a "standout" brand in a "highly disrupted environment," Merrill Lynch made the case for buying shares today, and matching actions to words, upgraded the stock from neutral to buy (with a $20 price target).
On the one hand, admits Merrill, Levi Strauss' exposure to the rough department store retailing environment is a concern. On the other hand, though, the weakness of incumbent department stores may open opportunities to make sales and grab market share elsewhere. The analyst's theory, therefore, appears to be that even if one avenue of retailing goods has been disrupted (by online shopping, for example), a strong brand will still find ways to sell (through online shopping, for example).
And Levi Strauss has "strong brand momentum," argues Merrill, creating a "potential upside to its sales and EPS" above and beyond what Wall Street is predicting for the company.
What analysts expect
So what exactly are those predictions calling for? According to data from S&P Global Market Intelligence, most analysts agree that Levi Strauss will earn about $1.03 per diluted share this year, and grow those earnings to about $1.27 per year over the next two years -- about an 11% compound annual growth rate.
This means that Levi Strauss stock costs about 16 times what it should earn this year, and about 13 times what analysts think it might be earning two years from now -- not an especially high valuation given the strength of the brand, the 11% growth rate, and the 1.8% dividend yield that the company pays its shareholders.
Furthermore, Merrill Lynch argues that Levi Strauss' current valuation of "8x F20E EV/EBITDA" looks "attractive" relative to the stock's "post-IPO peak of 11x" earnings before interest, taxes, depreciation, and amortization.
What it means to investors
But is it, really? Is Levi Strauss' valuation as attractive as it looks?
On the one hand, yes, I agree that on the surface, the stock doesn't look excessively expensive at 16 times expected earnings today, given the growth rate and the dividend yield (and the premium name brand). But the stock's resulting 1.25 PEG ratio isn't obviously cheap, either.
I also can't help but notice that while Levi Strauss sports an impressive $402 million in trailing net income, the company's actual free cash flow over the last 12 months is less than half that -- a mere $179 million, according to S&P Global data. When free cash flow doesn't back up even $0.50 for every $1 of claimed net income, I have to wonder whether a company's profits are as strong as they look on paper.
And of course, we must consider its recent earnings results.
Last quarter, Levi Strauss posted only a 5% increase in sales from its business (far slower sales growth than the 11% earnings growth we've been told to expect). What's more, actual earnings fell at the company -- down 63% year over year. Granted, the denim specialist says some of this decline can be attributed to the costs of bringing the company public five months ago. But even without those costs, earnings would have dropped 25% by my calculations. And once again, this seems to undermine Merrill Lynch's growth thesis for the stock.
Result: So far in 2019, Levi Strauss has earned just $0.44 per share toward the $1.03-per-share goal that Wall Street has set for it. Maybe the company will turn things around and make up the difference in the second half -- but I have to say I wasn't particularly encouraged by management's promise of "slightly up" earnings this year. With weak free cash flow, questionable predictions for future growth, and an increasingly tough economic environment for retail in America in general, I simply do not agree that now is the time to upgrade Levi Strauss stock.
