The freshly minted shares of Levi Strauss (NYSE:LEVI) popped in early April after the blue jeans maker impressed investors with strong revenue growth and healthy margin trends in its first earnings report since coming back to Wall Street. Still, the rally failed to make up for a the sell-off seen coming into the report, leaving LEVI stock below where it was just a few weeks ago, closing Wednesday at $22.75 a share.
This makes sense to me. The Levi Strauss IPO was over-hyped. Why? Quite simply, this is a blue jeans company that isn’t growing very quickly, isn’t supported by secular trends, doesn’t have big margin drivers, and is challenged by the still red-hot athleisure wave. All that adds up to a lower-$20’s price tag for LEVI stock in 2019. Anyone thinking of price levels closer to and above $25 in 2019 is getting ahead of themselves.
Levi’s first quarter numbers confirm this low-growth reality. While LEVI stock rallied some in response to the debut period numbers, it didn’t rally much, ultimately because an already-extended valuation is putting a lid on further upside.
This will remain true for the foreseeable future. As such, I think LEVI stock is best avoided until it drops closer to $20. Around $25, the stock is arguably overvalued.
Numbers Confirm Low-Growth Reality
Levi’s first-quarter numbers weren’t bad. They were actually pretty good. Reported revenue growth came in at 7%, while constant-currency revenue growth across every geography was 10% and more. The full-year guide calls for a slowdown, but not much, and implies mid-single-digit revenue growth for the rest of the year. Meanwhile, gross margins dipped 30 basis points, but the hit was all from FX noise, while core gross margins were strong thanks to more direct-to-consumer (DTC) sales. The opex rate dropped. Profits rose nicely.
Overall, the quarter was pretty good. But, if you zoom out, the quarter isn’t anything to get too excited about, and more than anything else, it just confirms Levi’s low growth reality.
Over the past three years, Levi Strauss has been a roughly 7% annualized revenue grower with flattish profit margins, led by healthy gross margin expansion and a rise in marketing expenses. The same is largely expected for 2019, with the guide calling for mid-single-digit revenue growth and flattish-to-slightly higher profit margins, due to gross margin expansion and higher marketing expenses offsetting one another.
So, Levi Strauss isn’t in the middle of a breakout. It’s just growing as usual, and usual here is sluggish revenue growth, flattish margins, and ultimately muted profit growth.
That isn’t anything to write home about. Instead, it’s actually something to worry about, especially since other apparel companies — namely, athleisure giants like Nike (NYSE:NKE) and Lululemon (NASDAQ:LULU) — are growing much more quickly.
The big takeaway? The blue jeans trend is still on the way out, and the athleisure trend is still on the way in. So long as this is what fashion decrees, Levi’s growth will remain sluggish, and that will ultimately keep a lid on LEVI stock.
LEVI Stock Doesn’t Have Much Upside Potential
At the current moment, LEVI stock seems fully valued, considering its long-term growth prospects.
The global apparel market is growing at a 5% compounded annual growth rate. Given the popularity of athleisure styles, I’d be surprised if Levi Strauss matched that growth rate and maintained market share over the next several years. Nonetheless, let’s assume a realistic best-case scenario and the company does just that, and revenue growth pans out at around 5% per year into 2025.
During that stretch, gross margins should continue to expand, given brand equity and pricing power, as well as a continued shift to a DTC model. But, that shift also requires investment, which will mean more opex dollars. Opex dollars will also go up because the company will need to market more in the face of stiff athleisure competition. So, the next several years will likely be defined by healthy gross margin expansion but muted opex leverage.
Putting all that together, I think Levi Strauss can do $2 in earnings per share by fiscal 2025. Based on a retail average 18x forward multiple, that implies a fiscal 2024 price target for LEVI stock of $36. Discounted back by 10% per year, that equates to a fiscal 2019 price target of roughly $22.
Bottom Line on LEVI Stock
In the lower-$20’s, LEVI stock is stuck in no man’s land in terms of valuation relative to long-term growth fundamentals. That’s why I’m not terribly interested in the stock here and now.
Still, I think it’s fairly likely that slowing economic expansion and bruising athleisure competition headwinds rear their ugly heads sometime later this year, and cause the jeans maker to report an earnings dud. That could drag Levi Strauss stock down to $20. If that happens, that would be an opportunity to buy.
Until then, I think it’s best to wait on the sidelines.
As of this writing, Luke Lango was long NKE.
More From InvestorPlace
- 2 Toxic Pot Stocks You Should Avoid
- 9 Best Dividend Stocks to Buy for Every Investor
- 7 Catalysts That Will Send Marijuana Stocks Soaring in 2019
- 8 Risky Stocks to Watch as Earnings Season Kicks Off
The post Red-Hot Athleisure Puts Lid On Jeans-Maker Levi Strauss Stock Upside appeared first on InvestorPlace.