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Levi Strauss (LEVI -17%) is sharply lower despite reporting nice EPS upside with its Q2 (May) results last night. The denim icon also reported its strongest yr/yr revenue growth in the past eight quarters at 7.8% yr/yr to $1.44 bln. However, that was a slight miss relative to analyst expectations with higher than expected FX playing a key role. LEVI only reaffirmed full year guidance, which we think is being viewed negatively given the nice EPS upside.

• The Americas segment was its strongest performer by far with revs up 17% (+16% CC) with DTC revenue up 16%, driven by double-digit growth in brick-and-mortar and e-commerce. While US wholesale was down mid-single digits, the US market grew low-single digits entirely as a result of DTC growth on an adjusted basis. LEVI also saw meaningful improvements in profitability across both channels.
• In Europe, revenue fell 2% on a reported and CC basis. DTC revenue increased 7%, reflecting growth in mainline, outlet, and e-commerce. However, Wholesale was down 11%. LEVI continues to expect Europe to return to growth in 2H. Asia revenue was flat yr/yr, but +6% CC. DTC revs increased 6% while wholesale was up 5%. China was down 10% as it was lapping 95% growth last year from the COVID reopening.
• Margins were a bright spot with record gross margin of 60.5%, primarily driven by lower product costs, the structural shift to DTC, and faster growth from its women's business. LEVI noted that DTC continues to not only be its fastest-growing business, but is also seeing real improvements in profitability. The strong margins helped to propel the robust EPS upside.
• LEVI expects its yr/yr acceleration in profitability will continue into 2H. It is seeing a strong response to its new product assortment with additional launches set for 2H. LEVI is also focused on full price sales, particularly in its mainline stores in the US. LEVI also continues to see momentum in its DTC business. Also, Europe overall is poised to return to growth in 2H and LEVI is confident in its plans for back-to-school and its holiday product and marketing campaign.
• So, why just a reaffirm for full year? LEVI is making significant changes to logistics strategy. LEVI is moving from a primarily owned/operated network in the US and Europe to one that will be more balanced between its own and third-party logistic providers. As it continues to pivot more toward DTC sales, its distribution network needs investment. That includes upgrading existing capacity with omni-channel capabilities. LEVI will be operating both new and old facilities for the rest of 2024, resulting in inefficiencies. LEVI expects to begin to see a favorable EPS impact in 2026 with larger benefits in 2027 and beyond. Also, FX headwinds have increased.

Overall, we think the biggest reason for today's weakness was LEVI's decision to only reaffirm full year guidance despite the large Q2 EPS beat. LEVI posted a similar size beat in Q1 and then raised FY24 EPS, so to not follow suit this quarter is spooking investors. It sounds like it's not a demand issue, but more related to higher costs and resulting inefficiencies from a distribution change with FX playing a role as well. However, given the move in the stock in recent months, sentiment was running high and the guidance was a letdown.