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3 Reasons Levi Strauss Stock Could Move Higher in 2021

By John Ballard - Feb 6, 2021 at 9:40AM

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Investors are undervaluing the apparel company's improving margins and the growth opportunities inherent in its new store concept.

Levi Strauss' (LEVI -4.71%) latest earnings report shows a company building momentum for a post-pandemic world. The biggest indicator of that was management's discussion on the earnings call about the growth opportunities of a new physical store format it's calling "NextGen."

While digital revenue -- both via the company's own e-commerce site and from the online sales of its wholesale partners -- increased a robust 34% in the last quarter, the company still sees its brick-and-mortar stores playing a vital role in growing the brand. And it's clearly playing offense there. 

Management mentioned three specific catalysts during the earnings call that could push the share price higher in 2021.

A mother and daughter wearing sunglasses and denim.

Image source: Getty Images.

1. Investing in the future of retail

In the fiscal fourth quarter, which ended Nov. 29, sales from Levi's direct-to-consumer business declined 5% year over year, due in part to store closures in some markets. Within this segment -- which includes company-operated stores and its online channel -- e-commerce sales stood out, increasing by 38%, but the new NextGen stores are looking like promising growth drivers.

During the quarter, Levi Strauss opened 21 of these smaller stores, which deliver an elevated shopping experience through inventory that's specially curated using local customer data, product customization using an interactive Tailor Shop app, and fitting rooms designed to help customers find their ideal fit. Obviously, Levi's omnichannel strategy involves more than just adopting the usual tactics like offering curbside pickup.

The best part is that these stores are generating a higher return on invested capital than Levi's average U.S. store, so it makes sense for management to open more of them. 

Levi Strauss plans to open 15 more NextGen stores in the U.S. in 2021. Management sees the potential to open more than 100 of these locations in the U.S. alone over the next two years. 

The direct-to-consumer business comprised 39% of total revenue last year, but management sees this higher-margin channel reaching 60% in the long run. Growth from company-operated stores will play a key role in that increase. 

2. Growth in non-denim categories

Levi Strauss has been talking up its opportunity to expand beyond its iconic jeans as well. Sales of women's tops and new categories such as sweats have been growing much faster than sales of jeans in recent years. Over the next decade, Levi's expects half of its revenue to come from non-denim categories, including accessories, footwear, and chinos. 

CEO Charles Bergh particularly likes the opportunity in tops. He noted that tops now total 21% of the business, up from 11% in 2015, but the company still has less than 1% market share in tops overall. "[T]ops today remains one of the biggest opportunities for us," he said during the fourth-quarter earnings call. 

3. More profits and dividends

For Levi's stock to move higher, investors will need to see growth on the bottom line. Profits plummeted during the pandemic, but they are trending back in the right direction.

Levi's reported a net profit of $57 million in the fiscal fourth quarter, up from $27 million in the previous quarter. But in its fiscal second quarter, during the first surge of the pandemic, the company booked a steep loss of $364 million. 

Levi Strauss is delivering well on margins, though, despite its revenue declines. Gross margin recently reached 55.3% -- its highest fourth-quarter level in company history. Management credited the improvement to price increases -- a great sign of brand strength in a relatively weak economic environment. Plus, a higher proportion of sales came from the direct-to-consumer channel.

"When revenues do recover to pre-pandemic levels, we expect to be a much stronger, more profitable business," CFO Harmit Singh said. Levi's reached an adjusted profit margin, before interest expense and taxes, of 10.6% in 2019. Management expects this adjusted margin to reach 12% once revenue fully recovers.

Based on recent trends, Levi's reinstated its quarterly dividend at $0.04 per share, bringing the annual payout to $0.16, for a dividend yield at current share prices of 0.8%. Management has said it will consider increasing the dividend later this year if business conditions continue to improve.

LEVI Total Return Level Chart

Data by YCharts.

Should you buy Levi Strauss stock?

Levi Strauss stock has underperformed other consumer-discretionary stocks over the last few years, but it has started to close the gap over the last six months, rising over 60% from last year's lows. 

The stock is currently trading at roughly $20 per share -- near its pre-pandemic price levels. In 2019, it would have been difficult to make the case that the shares were overvalued, trading at a price-to-earnings ratio of around 20. 

But with management forecasting higher margins and higher earnings once revenue fully recovers, Levi Strauss will be a more valuable business post-COVID than it was before. That should propel the stock price higher as management continues to execute its strategy of expanding the direct-to-consumer business, including launching its own secondhand denim store and growing non-denim categories. 

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