EUR 850.00 For Business Accounts Only

Morningstar | L Brands brand equity supported by Bath and Body Works demand, as VS turnaround fails to surface.

We recently lowered our moat rating for L Brands to narrow from wide, as consumer trends have opened the door for competition to materialize. This increase in competition has tempered our forecasts for gross and operating margin potential (averaging 38% and 11% over the next decade versus 39% and 14% in 2017), as we expect L Brands to drive in-store traffic with pricing 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 company perpetuates its footprint growth overseas (we believe the firm has a good long-run growth opportunity in China). We remain cautious over the near term as VS operating margin attempts to stabilize (the second quarter of 2018 marked the tenth 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 discontinued categories being comped, bralette penetration stabilizing, Victoria's Secret Beauty improving, and new structured bra introductions. L Brands believes it can sustain mid-single-digit annual growth driven by low-single-digit North America comp-store growth, flat to low-single-digit North America square-footage growth, mid- to high-teens direct sales growth, and low- to mid-20s international growth. Our outlook is slightly more tepid, calling for 0%-1% comps and 4% sales growth. Additionally, management still plans to invest in expanding the store base, which concerns us, particularly since L Brands still has material exposure to B and C malls (50% of locations). While 99% of the store fleet 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 deteroriate at the hands of online players . This is reflected in our estimates calling for operating margins to remain below 11% through 2023 versus a 16% adjusted three-year historical average.