Venerable but privately held denim jean manufacturer Levi Strauss announced that first-quarter sales will be pre-shrunk by as much as 8%, because of sagging demand in Europe and inventory cutting by U.S. retailers. If currency exchange rates are factored in, sales will drop by only 4% to 5% from a year earlier, but operating income will unravel by 12 to 15 percentage points.
Although it is still the world's leading manufacturer of jeans and sportswear under its Levi's, Levi Strauss Signature, and Dockers brands, it has had to compete with a flood of denim in the mass market, where customers might go to rival VF (NYSE:VFC) -- a producer of reasonably priced jeans under the Lee, Wrangler, and Rustler brands -- or even Gap (NYSE:GPS). Meanwhile, the premium division has seen market darlings like True Religion (NASDAQ:TRLG) or 7 For All Mankind find favor with the buying public. Analysts are expecting sales at True Religion to zip up 35% in growth in 2006 to $136 million, since it has become the No. 2 premium brand in the U.S.
While I can't cotton to the thought of paying $200 for a pair of jeans, my fashionista girlfriend can't see paying less, and a pair of 7 jeans does give her an, um, better fit. It's that premium market that Levi Strauss is targeting with its new RedWire DLX, which could just as easily be marketed in the electronics department as the clothing section of a store. It will feature a remote control, docking station, headphones for Apple's (NASDAQ:AAPL) iPod -- and a $200 price tag. A second premium jean, Capital E, will debut this year as well.
Premium jeans are but a small segment of the overall $14 billion denim jean industry, but this niche has seen revenues double to as much as $1 billion -- according to analysts at Wedbush Morgan Securities -- and continues to grow at a hefty clip. Sort of like the demand for jeans in the Cold War-era Soviet Union. And it's becoming a crowded field. In addition to True Religion and 7, other popular premium names include Lucky, Citizens for Humanity, Paper Denim & Cloth, and Chip & Pepper -- small manufacturers that go out of their way to ensure exclusivity of their brands.
Which is a problem for brands like Levi Strauss. Though it tries to differentiate itself from the crowd with a somewhat higher price than the discounters, it still has the impression of being a work clothes staple. As it tries to edge into the higher end premium market, it needs to be mindful of the denim glut and the profusion of premium jeans that seems to be a bubble of housing market proportions. Just as it climbs in, Levi Strauss may find that the bottom has dropped out.
With full year sales flat at $4.1 billion, and gross profits up just 5%, it's a scenario that could continue to sag like a pair of ill-fitting jeans.
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Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.
