Morningstar | Victoria's Secret Drags on L Brands' Performance as Transition Continues; Shares Undervalued
As narrow-moat L Brands attempts to pivot its Victoria’s Secret brand, results indicate that the segment’s turnaround remains at bay. With recent management changes undertaken at the brand and a reassessment to potentially expand the assortment (with opportunities stemming from eyewear, footwear, and swim), we believe the firm is attempting to restore brand equity that has fallen. But changes take time, particularly in a competitive retail environment, leaving Victoria’s Secret with 6% comp declines in December, in line with our forecast 6% shortfall for the fourth quarter. More concerning is the promotional landscape, which continues to pressure merchandise margin “significantly†at VS, indicating the brand is struggling to resonate with customers as it works through prior inventory disconnects.However, L Brands remains a bifurcated tale, with Bath & Body posting banner comp results, which increased 11% in December (on 4% last year). Moreover, the merchandise margins in the segment were higher, implying the product offerings were well demanded and innovation and product launches are spot on. Bath & Body now represents the majority of profits ($470 million in segment versus $539 million enterprise operating profits through the third quarter), thus we believe the segment should carry more weight with investors. Consolidated segment performance has led to a fourth-quarter earnings per share outlook from the company at the high end of previous guidance of $1.90-$2.10 per share, in line with our $2.06 estimate. We don’t plan to change our long-term prognosis for L Brands, which calls for a gross margin of around 38% over our forecast and higher operating expenses as the firm attempts to protect its brand intangible asset, leaving our terminal operating margin assumption around 11% (below the five-year historical average of 16%). We plan no change to our $43.50 fair value estimate and view shares as undervalued, particularly after the mid-single-digit downdraft.
L Brands is a holding company. Through its subsidiaries, the company is a specialty retailer of women's intimate and other apparel, personal care, beauty and home fragrance products. The company sells its merchandise through company-owned specialty retail stores in the U.S., Canada, the U.K., Ireland and Greater China, and through its websites and other channels. The company's other international operations are primarily through franchise, license and wholesale partners. The company has three reportable segments: Victoria's Secret, Bath & Body Works and Victoria's Secret and Bath & Body Works International. The company operates the following retail brands: Victoria's Secret, PINK and Bath & Body Works.
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