Down 12% at the time of this writing, the conversation around the pullback in Levi Strauss (LEVI) stock is revolving around their fiscal second quarter results. The company reported weak earnings on the basis that their IPO increased their costs. Frankly, I think this was primed for a pullback regardless of those earnings. LEVI stock was far too high in my opinion. In such a high market, this far along in a market cycle, I feel as though many investors are struggling to find something new. They jumped into this IPO chasing something. But when you look at Levi Strauss for what it is, the stock didn't make sense in my opinion.
With Levi Strauss you need to consider the actual size of this business. We have past financial statements, pre-IPO, and with three consecutive years of annual earnings in the low $0.70 range, the stock should not have been trading at nearly $24 a share. That's roughly 33x their trailing full year earnings.
Revenues increased 5% in the second quarter to $1.3 billion. For the year, revenues are up 6%. Following those rates of growth, Levi Strauss seems on track to create a second consecutive year of double digit growth in sales, though it should be noted that fiscal 2019 is going to miss the added infusion of sales from Black Friday.
Net income decreased 63% year over year to $29 million vs. $77 million in Q218. However, that net income for the first six months of fiscal 2019 is up 200% to $175 million. On an adjusted basis, net income decreased 17% to $69 million, while six month income increased 32% to $220 million. To an extent you can certainly credit the weak net income to costs associated with the company's IPO. However, operating income took a real hit as the company incurred higher expenses in advertising and promotions. Operating income declined 19% in Q2 to $63 million.
I for one won't be too hard on LEVI for the expenses. They're investing in direct to consumer initiatives, and deferred expenses from Q1 into Q2. Direct to consumer is an area that definitely has proven strong for Nike (NKE) . As more retailers are suffering weakness and store closures, companies like Levi Strauss have to take the initiative of getting their products to consumers themselves.
To me, this pullback was going to happen at some point, even with decent earnings. Excluding items, the company actually earned $0.17 per share, which beat out expectations of $0.13. Revenue also beat expectations. Yet the stock is suffering. I think it's all valuation. Because of how high LEVI ran off the IPO, the company had to report something special in the earnings to keep the momentum high.
Now that things have corrected, LEVI stock might be offering some opportunities. The company has a little over $1.3 billion in equity, while the stocks total market capital now comes in at $872.4 million. I don't love the debt levels, but LEVI has a strong cash position of nearly $861 million. The growing revenues tell me that there is a business here so long as the advertising expenses don't get out of hand.
One disappointing quarter isn't the end of the world. IPO mania simply got the best of the market, and the stock became too expensive. After this correction I think things are more in line. This is definitely a year of development for LEVI, and there could be opportunities to take advantage of it. Moving ahead, keep an eye on the cost effectiveness of their direct to consumer initiatives, and whether those advertising expenses level out.