The market punished Levi Strauss and Co (NYSE: LEVI) after the company released third-quarter results last week. The stock fell over 7% on Wednesday, and at first glance, it looks like the market overreacted.

The stock price has been on a tear since mid-August, rising over 23%, so it was not really surprising that the stock fell hard on disappointing results. The question now is whether or not the company justifies a PE of 18 given that earnings declined 9% from a year ago.


Earnings Decline Despite Robust Revenue Growth

This was the second time Levi reported quarterly financials after returning to the public markets in March. Third-quarter revenue rose 3.8% to $1.45 billion, $10 million ahead of analyst estimates. Revenues in Europe grew 14%, while Asia added 9% to the top line. The drag came in the Americas, where sales were down 3% from a year ago.

Net income fell 9% year on year, and EPS fell to 31 cents from 34 cents a year ago. This was still ahead of the 28 cents analysts expected.

Results in Line With Long-term Trend

Three times in the last decade, earnings have fallen more than 10%, and each time they have bounced back.

On the face of it, the 9% decline in earnings looks disappointing, but it should really be viewed in the context of historical trends. Looking back 10 years, annual revenue growth has averaged 3.3%, while growth in gross profit has averaged 5%.

Over the same period, income from continuing ops and adjusted earnings have both grown at 9 to 10% annually. Those are the average numbers, but from one year to the next they have been very lumpy. Three times in the last decade, earnings have fallen more than 10%, and each time they have bounced back. Of course, this doesn’t imply the downturn is over, but it is well within the norm for the company.

Over the same time period, gross and operating margins have improved steadily. This would correspond with a growing contribution from Asia and Europe too. It’s probably fair to expect average earnings growth to accelerate slightly going forward.


Is It Worth the Price?

Levi Strauss has been around for 166 years and is one of the most iconic fashion brands in the world. The brand gives it a strong moat, and profitability metrics are for the most part improving. The issue, therefore, is price.

The trailing price multiple is now 18 which, based on a growth rate of 9%, is roughly in line with the market. If growth ticks higher, the current multiple looks quite reasonable.

Levi’s valuation certainly looks attractive compared to peers like Lululemon, Capri, Gildan, VCF, and Under Armour. Columbia is arguably better valued after its growth decelerated rapidly in the last year.

The valuation is probably not low enough to make Levi Strauss a strong buy, though downside appears limited from here. It is, however, a stock worth watching if the sector begins to outperform. Institutional investors have so far ignored Levi, and there are only a handful of stocks in the sector.

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