Apparel stores are facing severe distress in the short term related to efforts to slow the coronavirus pandemic. Recent data from the U.S. Department of Commerce showed that clothing and clothing accessories retail sales in April were down 89.3% year over year. This will affect Levi Strauss (LEVI -6.88%), for which Wall Street analysts are currently predicting sales to be cut in half year over year for the May-ending fiscal second quarter.
The markets are always looking forward and pricing stocks accordingly. Levi's stock price is down almost 27% year to date, as investors discount a bad year ahead for the top denim brand. Analysts currently expect full-year sales to be down 15% in fiscal 2020 over the previous year. But with the shares trading at just 11 times the fiscal 2019 earnings level, is the stock a buy at these depressed levels?
How bad will 2020 get?
On May 12, Levi's announced it was starting to reopen its stores in the U.S. but will take a gradual approach to ensure the safety of everyone. This is encouraging news, which suggests the worst of the crisis is behind the company. But the next few quarters will still be challenging.
While Levi's has a growing online sales channel, 91% of its sales in 2019 were generated from wholesale or company-operated stores. Levi's e-commerce sales through its website and mobile app comprised just 5% of total revenue.
The dependence on department stores in the wholesale channel will be a problem for Levi's in the short term. Retailers that carry Levi's products like Neiman Marcus and J.C. Penney have already filed for bankruptcy. Nearly two-thirds of Levi's revenue last year came from the wholesale channel, which was already an area of weakness going into the crisis.
In the February-ending quarter, total revenue increased by 6% on a constant-currency basis, which was weighed down by a decline in wholesale revenue in the Americas region. That was in a strong economy, pre-coronavirus. Obviously, the wholesale channel will get even worse for Levi's this year, with the recent store closures, bankruptcies, and high unemployment levels affecting consumer spending.
Financial health and brand power
As bad as all that sounds, Levi's can get through this. It has $957 million in cash, which nearly offsets the $1 billion of total debt it held at the end of the most recent quarter. Plus, management is taking the right steps to keep the business on firm footing, such as matching inventory supply with reduced demand to keep margins above water.
Looking beyond the crisis, an investment in Levi's is all about the long-term durability of the brand. In the last five years, it seems the brand has been maintaining its iconic status in modern culture. The Levi's logo is emblazoned on Levi's Stadium in San Francisco, which hosted Super Bowl 50 in 2016. It also helps the brand's status when top celebrities are seen wearing the classic red label jeans at music festivals or social media, as Beyonce did at the Coachella music festival in 2018.
Unlike some top apparel brands that are struggling, Levi's has been performing relatively well. Management has done a good job promoting the heritage of classics like the 501 jeans while innovating for the future with modern fits and styles for customers who want more fashion-forward denim (such as the Levi's Made & Crafted collection). The company also experienced double-digit sales growth in smaller categories, such as women's and tops, in fiscal 2019.
The proof is in the pudding: From fiscal 2015 through fiscal 2019, Levi's grew revenue and earnings 28% and 76%, respectively.
Levi's is a time-tested brand. It has been around since 1853, and management believes its strategy to diversify across geographies, grow the online business, and expand its women's category will ensure the brand remains relevant for a new generation of consumers.
What is the stock's upside?
Currently, analysts expect Levi's to report $0.44 in adjusted earnings per share for the fiscal year ending in November. That puts the forward price-to-earnings (P/E) ratio at 28.5. The stock is currently trading at just 11 times its fiscal 2019 earnings, which looks really cheap, but it's unclear how long it will take for Levi's to fully recover its previous earnings level given the near-term pressure on sales.
Analysts currently expect Levi's to report an EPS of $0.84 by fiscal 2021. The stock currently trades at 15.4 times next year's earnings estimates, which leaves room for some upside if investors decide to bid the share price back up to Levi's average price-to-earnings multiple in 2019 of 18.
Assuming Levi's meets analysts' estimates in fiscal 2021 and the stock trades at its 2019 average P/E multiple, that would put the stock at $15, or 19.5% above the current share price.
There is upside in Levi's stock, but the potential return depends on how quickly consumers start spending again and how long it takes for Levi's to recover lost sales. No one really knows how fast or slow the recovery will be.
This year is a difficult environment for apparel stores, but I believe Levi's has the brand strength and enough resources to get through this downturn. If investors are patient and willing to endure near-term volatility, the odds favor investors making a satisfactory return off these lows.