Levi Follows Nike's Footsteps But Even With Everlasting Jeans, Business Model Success Doesn't Happen Overnight

On Thursday after market close, the jeans retailer succeeded to narrowly beat Wall Street estimates. But Levi Strauss & Co LEVI slashed its full year guidance as it reported a harsh drop in wholesale revenues and weakened U.S. sales which represent its largest market. When Bergh first joined the blue jeans company more than a decade ago, wholesale customers such as Macy’s Inc M and Kohl’s Corporation KSS made up more than 40% of Levi’s total business, but these days, their contribution comes down to less than 30%. However, focusing on direct-to-consumer channels like the all-mighty Nike Inc NKE has resulted in a rare bright spot of Levi’s quarterly report.

Fiscal Second Quarter Highlights

For the quarter ended on May 28th, Levi sales dropped 9% YoY to $1.34 billion, meeting Refinitiv’s estimate of $1.34 billion. The Americas' revenue tanked 22% to $609 million as wholesale revenue plunged, coming in below StreetAccount’s estimate of $639.5 million. Europe brought in $361 million with revenue dropping 2%, but topping the estimated $344 million Street Account estimated. On a brighter note, Asia revenue expanded 18% due to the strength of the DTC channel and amounted to $262 million, beating StreetAccount’s estimate of $230.2 million.

But the bottom line was a net loss of $1.6 million, or 0 cents per share, while during last year’s comparable quarter, Levi’s made a net income $49.7 million, or 12 cents a share. When adjusted, earnings came up to 4 cents per share, topping the expected 3 cents.

Wholesale Has Been Hit From Several Directions

With the consumer slowdown hitting the retail industry and internal inventory issues at Levi that resulted in items being out of stock, U.S. wholesale revenue tanked 22%. CEO Chip Bergh noted that Levi struggled with high inventory levels, which resulted in congested distribution centers that disabled the execution of wholesale orders. Bergh assured that wholesale inventory levels and customer filling rates have already significantly improved in the undergoing quarter (Q3).

Levi wholesale partners Kohl’s and Macy’s are also struggling with many challenges, including retail theft and curbed discretionary sending. Kohl’s Chief Financial Officer told analysts during the latest earnings call that losses from retail theft are expected to continue growing this year. Considering the troubles that Macy’s is facing, it’s hard to envision a rapidly declining company in an unfavorable industry pulling off a recovery or even for Kohl’s to maintain its current dividend for much longer. Macy’s even entered the battle of sales facing off the e-commerce titan Amazon.com Inc AMZN, whose Prime day is around the corner as it introduced Black Friday sales months before the holiday season to stay relevant and boost its competitiveness. While Macy’s will be offering discounts in the range between 20% and 75%, Amazon promises more deals than any prior Prime Day event.

Following Nike Was A Smart Move And A Rare Bright Spot

On the other hand, DTC revenues rose 13% as both company-operated stores and online sales grew with e-commerce revenue rising 20%.

A Dismal Guidance

As Levi’s continues to pursue Nike with its D2C strategy, U.S. wholesale revenue will continue to fall. The tightened revenue outlook for the year guides for a growth rate between 1.5% to 2.5% compared to a prior range of 1.5% to 3%., while analysts expected a 2.6% growth rate, according to Refinitiv. Adjusted EPS range has also been lowered from the prior range of $1.30 to $o 1.40 and are now expected to be between $1.10 to $1.20 with Refinitiv’s estimate from a survey of analysts being $1.29 per share.

Bergh also announced price reductions on about a half a dozen of price sensitive items, such as the 502 and 512 jeans, at its wholesale partnership stores such as Macy’s and Kohl’s. This move will dent margins over the quarter ahead, but the new price will still be higher than the pre-pandemic one. Bergh also added that these reductions will only apply to wholesale partnerships. Reductions will not take place at its owned stores nor internationally.

Chief financial and growth officer Harmit Sing revealed Levi is also planning for a higher tax rate in the second half of the year, which is yet another factor that contributed to the lower outlook. Th effective tax rate during the reported quarter was 78.4%, while during last year’s comparable quarter it amounted to 36.1%.

Taking A Page From Nike’s Playbook

While shifting away from wholesale has painful short-term consequences, this is part of a larger strategy of reshaping the business model for direct-to-consumer business that comes with stronger financials, higher gross margin, and perhaps most importantly, allows the company to take control of the consumer experience which is of essence for a jeans maker who promises quality never goes out of style. It paid off for Nike so it’s reasonable to expect that the Levi's will also reap the benefits of this strategy shift at some point.

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