Levi’s IPO is expected to price Wednesday night and IPO on Thursday. At $16, the high end of the $14-16 range, the company would have a market capitalization of $6.6bn.
I’d buy shares between $15-17 range. My $21 price target represents 17.5x 2020 EPS estimates 33% upside from the middle of the IPO range. I think buying on the IPO is appropriate for both a short term trade and investors with a investment horizon > 1 year. It has highly visible revenue growth from multiple drivers over the near and intermediate term, margin expansion drivers from product and channel mix, an underlevered balance sheet, strong free cash flow, and a reasonable valuation.
The fashion trends are blowing Levi’s way
The retro trend is in full swing which benefits Levi’s as it is an authentic American brand with nearly the most history I can think of in apparel (Brooks Brothers is older). When brands like Champion, Russell, and Fila are on fire you know the '80s and '90s are popular again. Fashion calls are not our skill set, but one has to recognize the environment.
Growth opportunities
- Women’s is the biggest revenue opportunity and the category only represents 29% of sales. Women’s has had a 14% CAGR since 2015.
- Tops only represent 20% of revenue. Levi’s is upside down in the often cited retail ratio for sales of tops to bottoms of 2:1.
- E-commerce only represents 4% of revenue and represents a large, global opportunity.
- Levi’s is still opening company owned stores at a HSD% growth rate.
- International is underpenetrated. Asia, Europe, Mexico and Canada all grew double digits in Q4.
Future acquisitions
Management is not looking to reduce debt levels. Acquiring companies would add new risk to a company with little acquisition integration history. It has operated Dockers and sub-brand Denizen. Still it could make more sense to acquire a brand(s) to assist in its growth opportunities in product categories, geographies, and distribution channels.
Margin outlook
The increase in the mix of DTC is a tailwind to gross margins. DTC is currently 35% of revenue and the mix has increased 200bps annually for the past three years. At the same time gross margins have expanded by 300bps. SG&A has grown at a double digit rate for the past two years, deleveraging 300bps. The combination of investments in the business and store growth have been the drivers. I expect to see SG&A growth to moderate over the intermediate term as the investment cycle ebbs.
Going public, but not been quiet
While it has been more than three decades since it was last public, the company has public debt. Management has reported quarterly results and hosted analyst conference calls for a number of years. Management is more familiar with public markets and investor expectations than a typical IPO.
Two pure play denim public companies
After True Religion went private who knew there would be two pure play denim public companies six years later. I would have thought that we would have had a denim cycle by now – does that mean we are in one now? I would have thought LULU would have been a short when the next denim cycle came back. Levi’s is the largest seller of denim jeans in the world and has 12.1% share of the $16.7bn market according to Euromonitor. Kontoor’s (Lee & Wrangler) operating margins are several hundred basis points higher, but are likely headed to low double digits as wholesale continues to be challenged and marketing will increase when it is spun off.
Valuation is in line with other well-known brands
PVH and Ralph Lauren trade at similar multiples as the IPO range for Levi’s has been set. PVH and RL trade at 8.4x 2019 EV/EBITDA estimates. I would expect to see LEVI shares trade at a premium to PVH and RL in the near term as estimates are revised upward. It does not have the luxury margins as the other companies, but revenues should prove more stable over a cycle.
Other things to consider
- Some may differ, but I consider pension liability like LT debt. As of Nov. 25, 2018 the company had $446mm of pension, long term employee related benefit liabilities, and post retirement obligations.
- The public will be offered A class shares that have one vote while the current owners will have B class shares with 10 votes. In our universe we aren’t accustomed to seeing different share classes. The Haas family will continue to have total control of the shares with their super voting class of shares. It doesn’t seem to have hurt Under Armour, so I don’t think the Street is going to hold it against Levi’s either.
- Black Friday, which is a significant sales event for its DTC channel, falls into 2020 which negatively impacts this year’s sales and EPS results.
- Levi’s has rolled out a RFID inventory management system over the past year.
- Only 15-20% of the product is made in China and Mexico combined.
- Levi’s has 824 stores, 500 shop in shops in the US and 3,000 globally, and 50,000 wholesale doors.
- The IPO allows the Haas family to cash out of some of their holdings without giving up control of the company. The family will receive proceeds >$300mm by selling some 21mm shares. The family will still collectively control ~80% of the voting power of Levi’s.
