EUR 850.00 For Business Accounts Only

Morningstar | Narrow-Moat L Brands Reports Mixed 2Q With Weak Victoria’s Secret Results; Shares Cheap

Narrow-moat L Brands reported mixed second-quarter results, with strength in the Bath and Body Works (33% of total sales) segment offset by continued struggles at Victoria’s Secret (58%). Total net sales grew 8% in the quarter, ahead of our 2% 2018 forecast, but at the cost of profitability, with operating margin dropping 330 basis points to 7.6% versus our forecast of 7.9%. As a result, management cut full-year EPS guidance for the second consecutive quarter to $2.45-$2.70, below our forecast of $2.91 and prior guidance of $2.70-$3.00. While near-term results crimp operating income, we believe our long-term forecast remains intact, including average sales that grow 3% and operating margin that levels around 11%, as the Bath and Body Works business will continue to succeed and the strength of the Victoria’s Secret brand will outlast the near-term fashion headwinds that have reduced segment profitability. After incorporating these near-term results, we do not plan to materially alter our $43.50 fair value estimate and see the pullback in shares as an attractive opportunity to invest in the name.

The Victoria’s Secret segment reported in-store comparable sales down 5%, in line with our forecast, but merchandise margins contracted significantly at the brand driven by additional in-store promotions to drive traffic. We continue to expect gross margin headwinds as inventory growth outpaces revenue growth in the quarter (up 17.6% versus 8.3%, respectively), seen in our full year 38.4% gross margin estimate for the firm (down 100 basis points from last year). While in-store sales have lagged, we are encouraged by management's renewed focus on online sales that grew 22% in the quarter. We expect the firm's improved omnichannel offering will allow the firm to capitalize on the brand's strength to drive higher-margin sales.

Bath and Body Works continues to perform, as comparable sales increased 7% (outpacing our estimate of 1%) with profitability declining 70 basis points to 17.5%. We see this decrease in profitability as a near-term headwind as the firm continues to renovate stores (expect to have 35% of the store base renovated by end of 2018) which will subside once the program has finished. Overall, these results are in line with our long-term expectations of 5% revenue growth on average over the next 10 years. We believe Bath and Body Works offers a unique value proposition to customers that cannot easily be competed away by online retailers such as Amazon because scented products are more difficult to sell online.