In spite of the pandemic-induced challenges, Levi Strauss & Co. (LEVI Quick QuoteLEVI - Free Report) continued to witness sequential improvement in business activities in fourth-quarter fiscal 2020 as well. Portfolio diversification, financial discipline, digitization endeavors and customer engagements helped the denim maker to post decent results that exceeded management’s expectations. Notably, the company continued with its positive earnings surprise streak and healthy cash flow trends.

While the company’s performance has been improving quarter-on-quarter basis, management cautioned about the recent resurgence of the virus. As a result, this California-based company expects net revenues, earnings and cash flows, to be significantly impacted for at least the first half of 2021. We note that the company projects first-quarter earnings below analysts' expectations.

Levi Strauss further stated that if the situation does not deteriorate, revenues should return to pre-pandemic levels by the end of 2021 with adjusted EBIT margins of 12% or more.

Shares of the global leader in jeanswear fell more than 6% in after-hours trading on Jan 27. Markedly, this Zacks Rank #1 (Strong Buy) stock has gained 35.7% in the past three months, compared with the industry’s rally of 56.9%. You can see the complete list of today’s Zacks #1 Rank stocks here.

Here's How Q4 Earnings Scorecard Looks

Levi Strauss posted adjusted quarterly earnings of 20 cents a share that comfortably surpassed the Zacks Consensus Estimate of 14 cents. This marked the company’s fourth successive beat in fiscal 2020. However, the quarterly earnings came below 26 cents reported in the year-ago quarter. This year-over-year decline reflects adverse revenue impact of COVID-19 pandemic and higher interest expense, partly offset by lower tax expense.

We note that net revenues of $1,385.9 million fell short of the Zacks Consensus Estimate of $1,394 million and declined 12% year over year on a reported and constant-currency basis. Nonetheless, the rate of decline has decelerated sharply from 27% and 62% witnessed in the third and second quarter, respectively. The 53rd week and Black Friday in the fourth quarter positively impacted total revenues by about three percentage points.

The decrease in the top line can be attributed to unfavorable impacts of the ongoing pandemic, including soft traffic and closures of company-operated and third-party retail locations for portions of the quarter and in certain markets.

Let’s Delve Deeper

Levi Strauss remains focused on digital initiatives. The global digital revenues, which comprises e-commerce sites and the online business of pure-play and traditional wholesale customers, surged roughly 34% year over year during the quarter under review, and represented roughly 23% of total revenues.

During the fourth quarter, wholesale revenues fell 15% but marked a significant improvement from third-quarter decline of 29%. Again, direct-to-consumer revenues decreased 5% on a reported basis but showed an improvement from a decline of 22% witnessed in the preceding quarter.

Soft brick-and-mortar traffic owing to the pandemic hurt direct-to-consumer revenues. Nonetheless, this was partly offset by 38% increase in company operated e-commerce business. Notably, direct-to-consumer locations and e-commerce accounted for 29% and 8%, respectively, of overall revenues in the reported quarter.

Levi Strauss intends to increase investments in own retail stores and e-commerce businesses. Management pointed that growth of direct-to-consumer business will be accretive to gross margin and improve the overall profitability.

Impressively, the company is accelerating new omni capabilities, including Buy Online, Pick-up In Store, line-queuing, same-day delivery, appointment scheduling, and mobile checkout. The company has also rolled out additional payment options like Afterpay to all its sores in the United States and expanded ship-from-store capability to Canada, the U.K. and Germany with plan to continue deployment in Europe in early 2021.

During the quarter under review, the company opened 21 next-generation stores. It operates five next-generation stores in the United States and has plans to open around 15 full-price next-generation stores in fiscal 2021.

Meanwhile, the company announced new Levi's for Target limited-edition collection. The collection features a range of home and lifestyle assortments along with marking the Levi's first Home partnership. Moreover, the company’s Red Tab roll out at Target is on track to expand to 500 stores by Fall 2021.

How Margins Fare?

Adjusted gross profit amounted to $757.1 million, which declined 11% from the year-ago quarter. Adjusted gross margin — excluding the pandemic-related charges — expanded 30 basis points to 54.6% on account of price increases, a greater proportion of sales in the higher-margin direct-to-consumer channel, reduced promotions and healthy inventory.

Furthermore, adjusted SG&A expenses fell 9% to $643.7 million, owing to cost-reduction efforts. Meanwhile, adjusted EBIT came in at $113.4 million, down 22% year over year. Also, adjusted EBIT margin contracted 110 basis points to 8.2%.

Regional Performance

Net revenues in the Americas tumbled 12% to $767.3 million. While direct-to-consumer net revenues fell 5%, wholesale net revenues decreased 15%, thanks to the COVID-19 impact. This was partly offset by higher e-commerce revenues on account of increased traffic and conversions.

Net revenues in Europe decreased 9% to $403.2 million as rise in coronavirus cases led to the temporary closure of stores in maximum part of the region in the month of November. Nonetheless, e-commerce business remained robust due to increased traffic and higher conversion.

Net revenues in Asia were down 14% to $215.3 million due to the adverse impacts of COVID-19. In the quarter, the company witnessed a significant revenue decline of $18 million in India, where the impact of pandemic on traffic remained pronounced in spite of most stores remaining open during the quarter. Excluding India, net revenues in the region fell 8%. Constant-currency revenues in China were nearly flat year over year as high-single digit increase in direct-to-consumer business was offset by reduced sales to franchisees. We note e-commerce revenues increased on higher traffic and conversion. Management is highly focused in Asia, given increased brand awareness and significant opportunity to enhance sales.

A Sneak Peek into Other Metrics

Levi Strauss ended the quarter with cash and cash equivalents of $1,497.2 million and short-term investments of $96.5 million. These were complemented by $714 million available under its revolving-credit facility. This resulted in a total liquidity position of roughly $2.3 billion.

As of Nov 29, 2020, long-term debt and total shareholders’ equity were $1,546.7 million and $1,299.5 million, respectively. Further, the company’s leverage ratio was 4.9 at the end of the quarter, up from 1.4 at the end of the year-ago quarter. Total inventories were down 8% to $817.7 million year over year.

For three-month period ended on Nov 29, 2020, net cash provided by operating activities was $228.7 million. The company generated adjusted free cash flow of $172 million during the said period.

Management incurred capital expenditures of $130 million during fiscal 2020. The company anticipates capital expenditures of $210 million in fiscal 2021 in areas such as e-commerce, omni-channel initiatives, artificial intelligence, data analytics and the SAP upgrade.

Additionally, the company opened 90 stores during fiscal 2020 and added another 85 doors from organic acquisitions, thereby taking the total company-operated store count at year end to 1,042. The company informed that it intends to open 80 stores worldwide.

Outlook

Levi Strauss envisions first-quarter fiscal 2021 revenues to be down by a high-teens percentage in constant currency, thanks to tough year-over-year comparison. Management informed that first-quarter fiscal 2020 witnessed minimal impact of COVID-19 pandemic and had a Black Friday. However, first-quarter fiscal 2021 is grappling with store closures. The company informed that currently 40% of stores in Europe, and 17% globally of all company-operated and franchised stores are closed, with others operating on reduced hours.

Management stated that it expects stores to remain closed through the remainder of the current quarter. As a result, first-quarter fiscal 2021 earnings are likely to take a hit of 10-12 cents a share. Levi Strauss guided first-quarter adjusted earnings in the band of 20-24 cents a share. The company’s earnings projection is below the current Zacks Consensus Estimate of 32 cents.

Moreover, the company anticipates adjusted gross margin expansion of 100 basis points.

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