Levi's DTC growth slows to 2% from 8%, and tariff refunds fill the gap

Levi Strauss & Co. saw its direct-to-consumer business stumble in the fiscal third quarter, with organic revenue growth slowing to 2 percent from 8 percent in the second. The stumble coincided with the brand's first net revenue miss in two years, according to Wells Fargo.

The stock softened rather than collapsed. Shares were down 3.8 percent to $18.77 in midday trading on Thursday, a modest decline in a market quick to punish any sign of weakness.

Chief executive Michelle Gass named the reasons plainly: extreme heat in Europe and mismatched marketing in the United States. She added that the direct business is already back on track and is expected to post midsingle-digit growth in the current quarter.

Harmit Singh, the company's outgoing chief financial and growth officer, told analysts on a conference call that Levi's received about $80 million in tariff refunds during the quarter, almost all of what it expects. About $60 million has already been redeployed.

Singh split the redeployed money into three equal parts: a third to marketing, a third to distribution and a third to promotional activities. In the third quarter, he said, the majority went to promotions, with a little advertising and some inventory clearance.

The fourth-quarter mix changes. Singh said spending will be largely advertising, marketing and distribution, with only slight promotions. About $25 million was spent during the third quarter, and about $35 million is slated for the fourth.

He said the money would fund extra marketing to lift demand, better supply chain capabilities, and sharper prices for shoppers during the key holiday promotions. "Our view is, the tariff refunds were timely," Singh said.

Timing mattered because distribution costs in the US remain higher than expected, Singh said. Marketing is also one reason direct margins often fall short of wholesale margins, since wholesale partners take on much of the expense and effort of promoting the product.

What dented the direct business

Back-to-school traffic and demand were weaker than expected, Gass said, partly because the brand over-emphasised loose fits just as US consumers turned to low-rise ones. "The team got after it very quickly, and we sharpened our focus," she said.

Loose styles are not being abandoned. Gass called them "an important business" and a "big volume driver", even as the marketing mix was adjusted to the low-rise shift among American shoppers.

Europe's brutally hot summer then took a toll on direct sales. "When the temperature started cooling and weather moderated, we saw the trends come back," Gass said, calling quarter-to-date direct trends in Europe "very robust, very positive and robust."

Wholesale in the region did better. "We had an incredible wholesale business," Gass said, adding that the brand is very healthy in Europe. That wholesale strength, alongside the refunds, is what held up profits and margins in a rough quarter.

How analysts read the quarter

BNP Paribas analyst Laurent Vasilescu called it a "no harm, no foul" situation. Needham analyst Tom Nikic called it a "very noisy print" but was encouraged by the "reacceleration in DTC", adding: "Fortunately this seems to be just a short-term blip."

Neil Saunders, managing director of GlobalData, said Levi's had a solid third quarter even if some of the heat had come out of the growth figures. He said the slower growth does not take away from a very sound underlying strategy.

Levi's, under Gass and her predecessor Chip Bergh, has built credibility and is getting the benefit of the doubt. Strong companies that trip get a pass, while companies that keep falling down get reevaluated, so the direct reacceleration has to continue.

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Images: Levi's