EUR 850.00 For Business Accounts Only

Morningstar | Bath & Body Provides the Silver Lining on L Brands’ Performance, Driving 2019 Profit Growth

We lowered our moat rating for L Brands to narrow from wide in 2018, as consumer trends had opened the door for competition to materialize. This increase in competition has tempered our forecasts for gross and operating margins (averaging 38% and 11% over the next decade versus 41% and 15% over the past five years), as we expect L Brands to drive in-store traffic with price and promotion in future periods. In our opinion, the firm's economic moat stems from its brand intangible asset in an industry characterized by prioritization of quality and fit, along with a rising global awareness that has the ability to continue expanding as the firm perpetuates its footprint growth overseas, with a good long-run growth opportunity in China. We remain cautious over the near term as Victoria's Secret's operating margin attempts to stabilize (the first quarter of 2019 marked the 13th consecutive quarter of operating margin declines for the segment) but see promise in the medium term, with potential catalysts for an inflection point in sales and margin performance stemming from bralette penetration stabilizing, Victoria's Secret Beauty innovation, new structured bra introductions, and the resurrection of adjacent businesses (swim).L Brands' existing growth framework seeks 5%-10% annual sales growth driven by low-single-digit North America comp-store growth, flat North America square footage, mid-teens direct sales growth, and low-20% international growth. Our outlook is more tepid, calling for 1% comps and 2% sales growth over the next five years. Management is still investing in its store base, but we expect it to strategically evaluate locations as leases come due, given its exposure to B and C malls (around 50% of boxes). While nearly the entire store fleet (99%) is cash flow positive on an aftertax cash basis, we think store profitability could be pressured in the long run as more of L Brands’ own sales shift online and as mall traffic is likely to further deteriorate at the hands of online players. This is reflected in our forecast for operating margins to remain below 11% until 2026 versus a 14% adjusted three-year historical average.