For those who aren’t familiar with the name, some basic facts: Levi’s is a 155-year-old producer of jeans and other branded apparel. The company generated 4.4bn in LTM revenue, split across three brands: Levi’s (the flagship; 73% of revenue), Dockers (business casual wear; 21% of revenue), and Levi’s Signature (low-priced jeans sold at places like Wal-Mart; 6% of revenue). Distribution is primarily via chain retailers and department stores, with the largest customer, JC Penney, accounting for 9% of revenue. The company also operates 245 of its own stores, accounting for less than 10% of revenue. Geographically, sales are split 54/46 between the Americas and Europe/Asia.

 

** Two Things That Stand Out **

 

Levi’s doesn’t really fit the stereotype of a dying, near-bankrupt retailer. In fact, a review of the history of the company reveals two pretty admirable qualities:

 

First, selling branded jeans is a surprisingly steady business. Perhaps Levi’s reputation for offering relatively standard cuts at reasonable prices insulates it from the volatility of fashion trends. Perhaps Levi’s customer base, which is 72% male, is less fickle. Whatever the case, the result is 80+ quarters, or 20+ years, without an operating loss. Through the recession of 2001-2002, Levi’s generated operating margins of 9.4%. Through the recession of 1990-1991, Levi’s generated operating margins of 15%. And, although my data is less reliable going back to the 70s and early 80s, through the recession of 1973-1974, as well as the recession of 1981-1982, Levi’s was solidly profitable, with operating margins of at least 4-5%. This consistency is not specific to Levi’s either. If you look at VF Corp, Levi’s closest comp, their jeans-wear business is also remarkably stable.

 

Interestingly enough, when Levi’s does struggle, the source is almost always industry and/or company-specific. For example, in 1999, operating margins fell to 6.4% on poor managerial execution, including a complete miss of the baggy-legged jeans craze. In 2003, the culmination of several industry trends resulted in margins hitting a low of 4.7% (after backing out a one-time gain).

 

The silver lining here – and this is the second of the admirable qualities that a reading of the history reveals – is the hard-to-kill nature of the business. Going back through old magazine articles is particularly revealing in this regard. For example, in 1999, Forbes published a piece entitled, ‘How Levi’s Trashed A Great American Brand.’ The author paints a picture of complete internal chaos and a company, “[coming] apart at the seams.” Yet in the nine years since that article was written, Levi’s operating profits increased by 78%, averaging 439mm per annum.

 

While it is indeed true that Levi’s is not as hot of a brand as it once was, it isn’t going away either. Yes, revenues, after peaking at 7.1bn in 1996, have fallen to (and stabilized in) the 4bn range. Yes, operating profits are lower today than in the 1990s. But it is important to put these numbers in the proper context, especially in light of the fact I am recommending the bonds – which will work out as long as the company just stumbles along – and not the equity.

 

** More Numbers… **

 

Levi’s generated LTM EBITDA of 650mm, versus a current interest obligation of 139mm, resulting in an EBITDA interest coverage multiple of 4.7x. LTM EBIT was 580mm, resulting in an EBIT interest coverage multiple of 4.2x. To offer some long-term perspective in relation to these figures, I’ve include the historical record of sales, EBIT and associated margins below:

 

 

1990 – 4.2bn

1991 – 4.9bn

1992 – 5.6bn

1993 – 5.9bn

1994 – 6.1bn

1995 – 6.7bn

1996 – 7.1bn

1997 – 6.9bn

1998 – 6.0bn

1999 – 5.1bn

2000 – 4.6bn

2001 – 4.3bn

2002 – 4.1bn

2003 – 4.1bn

2004 – 4.2bn

2005 – 4.2bn

2006 – 4.2bn

2007 – 4.4bn

LTM – 4.4bn

 

 

1990 – 622mm (14.8%)

1991 – 750mm (15.3%)

1992 – 677mm (12.1%)

1993 – 852mm (14.4%)

1994 – 969mm (15.9%)

1995 – 987mm (14.7%)

1996 – 948mm (13.4%)

1997 – 853mm (12.4%)

1998 – 691mm (11.6%)

1999 – 329mm (6.4%)

2000 – 473mm (10.2%)

2001 – 398mm (9.3%)

2002 – 388mm (9.4%)

2003 – 192mm (4.7%)

2004 – 413mm (9.9%)

2005 – 548mm (13.0%)

2006 – 544mm (13.0%)

2007 – 557mm (12.8%)

LTM – 580mm (13.2%)

 

 

 ** The Worst Case Scenario **

 

Let’s consider the worst-case scenario in detail. Suppose that Levi’s has a terrible 2009, is unable to meet its interest obligations, and goes bankrupt. What would the bonds be worth in a reorganization? The valuation of course depends on what the creditors decide ‘normalized’ EBIT is. I think that 240mm is a conservative figure. That equates to a 6% margin on 4bn of revenue (compared to 13.2% and 4.3bn today). Of course, interested readers can construct their own sensitivities. Capitalizing 240mm at 7x (which is what VFC is valued at today, after falling 40% from early September) results in a total enterprise value of 1.7bn. Assuming a complete drawdown of the revolver, 100mm in DIP and administrative expenses, and a full recovery for the senior secured debt, there is still nearly 1.05bn in value left over for the unsecured bonds. This implies an eventual recovery of more than 50 cents on the dollar (including the 294mm in pension obligations).