Wall Street mistook a fashion trend for a turnaround.
Shares in Levi Strauss & Co. fell as much as 16% in pre-market trading after second-quarter sales missed expectations. Although revenue in the three months to May 26 came in at US$1.44 billion ($1.95 billion) — only just below the US$1.45 billion average of analysts’ estimates — the performance should have been better given that denim is one of the hottest looks around right now.
Let’s not forget that shout-out from Beyonce in March, prompting the company to change its Instagram name to “Levii’s.” That’s the kind of publicity that other apparel companies can only dream of.
Denim is having a moment, with wide-legged styles in the ascendance. And Michelle Gass, the former Kohls Corp. chief executive officer who took the helm at Levi’s at the start of this year, is certainly taking advantage of the swing from slouchy leisurewear to so-called “hard pants.”
Straight, loose and wide-legged styles now account for more than 50% of bottom-half apparel at Levi’s, and sales rose 21% in the second quarter. Demand for women’s clothing was particularly strong, with sales up 22% through Levi’s stores and its own website. It’s now America’s biggest seller of women’s jeans.
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Gass’ strategy of selling more denim clothing that isn’t jeans, such as tops, dresses and skirts — what she dubs the “head-to-toe denim lifestyle” — is contributing to this success.
Products beyond pants were “selling like crazy,” Gass told analysts on Wednesday. Sales of western-style shirts rose 40%, with denim skirts and dresses up by a triple-digit percentage. This has helped the company to avoid markdowns, contributing to a record gross margin of 60.5%
Yet this looks at odds with the slight second-quarter sales miss, as well as the company’s forecast for full-year revenue to be up only between 1% and 3%.
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Of course, Gass might be hoping to under-promise and over-deliver. After all, some consumers remain cautious in the US and Europe, while China’s post-reopening recovery has stalled. But there are other risks that Levi’s must manage.
First of all, the company wants to sell more of its products through its own website and stores. This should be more profitable as there’s more control over what to put on sale rather than at, say, a department store.
But this strategy also has pitfalls. Not only does online delivery incur costs, but Nike Inc. has demonstrated that selling less through third-party stores can give oxygen to rivals. Given that everyone from Associated British Foods Plc’s Primark to premium players like Paige are doubling down on the category, Levi’s must avoid ceding sales.
It’s also trying to move into non-denim categories, such as T-shirts, which consumers tend to buy more often. So far, this is paying off. But it does pit the company against brands already well-known for these products, as well as cheaper rivals.
Meanwhile, Gass is overhauling the business, cutting costs and moving from a logistics network that it wholly owns and operates to one that includes other providers. For the remainder of the year, this will mean that it bears the cost of running both types of facility. There is also a danger of supply-chain snarl-ups during any such transition.
Luckily for Gass, denim trends move at a glacial pace. Skinny fits ruled for roughly a decade, from about 2005 to 2015. So the current fashion for bigger jeans should have more room to run.
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Denim is continuing to sell well, although it’s performing better in women’s apparel than men’s, according to retail intelligence company EDITED. Wide-legged and bootcut styles are the most in-demand, it said.
But Gass and Levi’s investors must be on watch for signs that we are at peak denim. Whether the popularity endures into the fall will be telling. After the shares almost doubled from September through to early June, they won’t want to be caught out wearing the wrong pants.
Charts: Bloomberg
