EUR 850.00 For Business Accounts Only

Morningstar | L Brands Ends 2018 With Everything on the Table for the Turnaround at VS; Long-Term Thesis Intact

Narrow-moat L Brands'  fourth-quarter  story remained consistent with bifurcated trends in recent periods, as Victoria’s Secret struggled and Bath & Body Works outperformed. Full-year results tracked our estimates, with sales growing 4.8% on 37% gross, and 10.9% adjusted operating margins (versus our estimates of 4.9%, 37%, and 10.5%, respectively). While performance has been volatile with VS, the new brand CEO could reinvigorate the merchandise, and we remain confident in our long-term forecast of mid-single-digit revenue growth, 38% gross, and 10.7% operating margins over our 10-year forecast, on average. Management offered 2019 targets of low-single-digit total comps, lower gross margin, and selling, general, and administrative deleveraging leading to EPS of $2.20-$2.60 relative to our calls for down 1% and $2.75, respectively, which included rising gross margin. We plan no material change to our $43.50 fair value and view shares as attractive after the high-single-digit drop following results.

Victoria’s Secret's struggles were pronounced in 2018, with store comps down 6%, in line with our estimate, and merchandise margin down significantly. Further, management called for more store closures and merchandise assortment changes set to arrive in the back half of 2019, implying further promotion efforts to clear existing inventory. VS Direct was a bright spot, growing 16% as it improves its online platform. We expect new brand management should be able to leverage the brand’s clout with consumers as they retool and optimize their assortment and advertising to new generations.

Bath & Body continues to outperform, with store comps up 8% (above our 5% estimate) and the direct channel increased 31% as on-trend product led to lower discounts and higher average unit retail in the year. This performance validates our thesis that Bath & Body is insulated against the e-commerce threat, as scented products are more difficult to sell online, unless on a replenishment basis.

We continue to have a favorable view of the large-scale changes (closing Henri Bendel, selling La Senza, and resetting the dividend) that the firm enacted over the year. These strategic efforts freed capital to reinvest into the core Victoria’s Secret and Bath & Body brands in hopes of expediting the turnaround and fueling long-term growth prospects through product innovation, store renovations, and e-commerce investments.