EUR 850.00 For Business Accounts Only

Morningstar | Lopsided Performance of L Brands' Segments Warrants the Assessment of a Spin-Off; Shares Undervalued

On the heels of no-moat Gap’s February 2019 announcement that it would carve into two separate businesses, activist hedge fund and shareholder Barington Capital has called for a similar push at narrow-moat L Brands. While investors sent Gap shares up more than 20% on the news that Old Navy would be a stand-alone business, we contend that such a breakup could be even more favorable for L Brands given the lucrative plus-20% operating margin performance its Bath & Body Works segment generates and the upside two distinctly focused businesses could create. Old Navy same-store sales growth has already begun to slow, holding flat in the final quarter of 2018, and enterprise operating margin has contracted more than 500 basis points since 2013, a trend continuation that might put such a transaction at risk.

On the flip side, Bath & Body Works continues to bring solid same-store sales growth on a mature fleet, printing an 8% increase in 2018 on top of a 2% rise in 2017, with every year post-recession tying up positive same-store sales marks and stable segment operating margin results. In our opinion, valuing Bath & Body Works as a stand-alone business would render an equity value per share ($35) that is higher than the market capitalization of the whole enterprise today, assuming a 1% sales and 2% operating margin uptick over our base case in the combined model for each segment. In a $50 sum-of-the-parts valuation, this implies those holding Bath & Body owners would receive Victoria's Secret shares worth $15. Given that operating problems at Victoria's Secret haven’t leaked into the Bath & Body business, we’d expect value creation should stem from the focus of leadership that is solely exposed to the lingerie business, while the team at Bath & Body could work to maximize cash flow and pay down debt. We view L Brands as undervalued, trading at a 35% discount to our $42 fair value estimate and believe that equity value could be unlocked if the firm was to split into two.

For further details surrounding our sum-of-the-parts valuation, please see our April 2019 report, “Breaking Up Is Hard to Do but L Brands’ Spin Could Prove Lucrative.”