L Brands Inc. (NYSE: LB) is HOLD. L Brands, the parent company of Victoria’s Secret and Bath & Body Works, is a large-cap retailer with a focus on women’s apparel and beauty and personal care products. On February 20, 2020, the company announced an agreement to sell a majority interest in Victoria’s Secret to Sycamore Partners, a private equity firm. On May 4, the companies agreed to terminate the deal; however, LB continues to prepare to operate Bath & Body Works and Victoria’s Secret as standalone companies and has retained Goldman Sachs and J.P. Morgan as advisors on the separation.
The mall-based segment of retail — in which LB competes — has been under increasing pressure from online retailers, who are rapidly gaining share. To thrive in this environment, retailers need to have products that sell easily at brick-and-mortar stores and management teams that can make quick merchandising decisions. We believe that Bath & Body Works has these qualities, and note it has performed well despite the slowdown in brick-and-mortar retail. However, Victoria’s Secret continues to deteriorate despite management’s efforts to cut costs and boost sales through changes in merchandise assortment and increased marketing efforts. Margins have suffered due to missteps in merchandise selection and the increased use of promotions. Reflecting these challenges, the company slashed the annual dividend and closed 59 underperforming Victoria’s Secret stores in the U.S. and 7 international stores in 2019. It plans to close 250 stores in North America in 2020.
On the positive side, the company has invested heavily in technology and logistics, and continues to boost customer engagement through social media and direct mail. It has also been expanding in China and strengthening the White Barn line at Bath & Body Works. We expect sales growth at standalone Bath & Body Works to be driven by strong e-commerce and new store openings.
On November 18, L Brands reported fiscal 3Q21 results for the quarter ended October 31, 2020. Net sales increased 14% to $3.055 billion, and came in $380 million above the consensus estimate. Comp sales were up 28%, reflecting a 56% increase at Bath & Body Works and a 4% increase at Victoria’s Secret. The company posted 3Q adjusted earnings of $1.13 per share.
In response to the pandemic, the company has furloughed employees, cut executive salaries, reduced spring inventory, temporarily suspended dividends, and reduced 2020 capex from $550 million to $250 million. It has also amended its revolving credit facility, and in the second quarter, the company reduced home office headcount by 850 associates.
Management has not provided full-year guidance due to the current economic uncertainty. However, it noted that it expects challenges to generating store growth due to capacity limitations, fewer stores hours and the potential for further pandemic-related restrictions. It also expects increased store costs due to safety and social distancing protocols, domestic supply chain wage inflation, and higher fulfillment and shipping expenses in the direct channel. Marketing expenditures, which were cut in the first half, are expected to return to more typical levels going into the holiday period.
EARNINGS & GROWTH ANALYSIS
In order to further separate its businesses, beginning in the third quarter of 2020, L Brands now has two reportable segments, Victoria’s Secret and Bath & Body Works. International and Other, which were previously separately reported, are now included within their respective brand.
At Bath & Body Works, 3Q sales rose 54.9% to $1.7 billion, with store sales up 38%, while the direct channel, posted growth of 132% and international grew 55%. Store-only comps were up 38% and Store and Direct were up 56%. Body care and home fragrance each grew more than 30% in 3Q, and due to the pandemic, the segment continues to benefit from substantially higher demand for soaps and sanitizers (which accounted for about 21% of the business in 3Q versus 14% in 2019). Volumes have been elevated since the pandemic started, and the company has been ramping up fulfillment capacity. The merchandise margin
improved significantly year-over-year, due to improvement in inventory management and fewer promotions. However, in the fourth quarter, it plans to spread holiday promotions over more days, with overall higher price points due to in-store capacity limitations, fewer store hours and the potential for further restrictions. The company expects 56 openings or remodeled stores this year and 30 store closures. Management reiterated its plan to operate Bath & Body as a standalone company.
Third-quarter net sales at Victoria’s Secret declined 14.2% to $1.35 billion. Store-only comps (which exclude online and factory outlet sales in the U.S. and Canada) were down 10% due to lighter traffic, while Store and Direct comps grew 4% on improvement in the Lingerie, PINK and Beauty segments. The adjusted operating income was $115 million, versus a loss of $70 million a year earlier. The company has been working to reduce in-store selling costs in addition to improving product assortment and marketing effectiveness. Merchandise margin improved in the third quarter, driven by a 22% increase in AUR and a reduction in promotional activity. The company closed its unprofitable flagship store in Hong Kong during 2Q, and in 3Q it restructured flagship store leases in mainland China and entered a joint venture between Victoria’s Secret U.K. and NEXT. The company closed 239 stores year-to-date and plans about 250 Victoria’s Secret store closures in North America this year. While sales will decline as a result of the closures, management expects little impact on margins. Management has also noted that it continues working with advisors to pursue options to separate Victoria’s Secret from Bath & Body Works.
The overall 3Q gross margin rose 870 basis points to 34.1%, reflecting substantial improvement in the merchandise margin, as well as significant buying and occupancy expense leverage. We are raising our FY21 estimate to $2.38 from $1.25 per share based on significantly better-than-expected 3Q results. We also raised our FY22 EPS estimate to $2.54 from $2.15. We expect continued headwinds at Victoria’s Secret, offset by continued
strong sales at Bath & Body Works.
FINANCIAL STRENGTH & DIVIDEND
Moody’s recently lowered its credit rating on LB to Ba2/negative from Ba1/stable; LB is rated B+/stable by S&P and B+/stable by Fitch.
LB cut its quarterly dividend from $0.60 to $0.30 per share beginning with the March 2019 payment. In the first quarter, it temporarily suspended the dividend in response to COVID-19.
MANAGEMENT & RISKS
Company founder Leslie H. Wexner stepped down as Chairman and CEO of L Brands in May 2020. Andrew Meslow, the CEO of Bath & Body Works, became the new CEO, and Sarah Nash became the company’s new chairman. Mr. Wexner will remain chairman emeritus and a member of the board. The CFO is Stuart Burgdoerfer.
In early 2019, John Mehas replaced Jan Singer as the CEO of Victoria’s Secret. Mr. Mehas was most recently the president of Tory Burch, and previously led Polo Ralph Lauren brand Club Monaco.
Like other specialty retailers, LB faces significant risks and competitive pressures. As we have noted in reports on other companies, we don’t believe that retailers are in scarce supply. Barriers to entry are generally low, and customers have few qualms about switching stores to find lower prices or more popular styles.
The retail industry is also facing higher costs for cotton and other raw materials as well as for labor in lower-wage source countries such as China, which will likely hurt margins. However, management believes that the company is better positioned than peers with respect to commodity costs. Victoria’s Secret relies less on cotton than many peers, as it generates approximately 40% of its sales from beauty and personal care products; however, these products also face pressure from rising costs.
L Brands Inc., based in Columbus, Ohio, sells lingerie, personal care and beauty products, apparel and accessories. The company has 2,619 specialty stores in the U.S. and 90 stores internationally in Canada, the United Kingdom and China. It also sells its products through franchises in over 700 locations worldwide. The company’s brands include Victoria’s Secret, Pink, Bath & Body Works, and White Barn Candle Co.
Following the release of 3Q results, LB shares were trading at new highs. The 52-week range is $8-$40.79.
On the fundamentals, LB shares are trading at 17.6-times trailing 12-month earnings and 16.6-times our FY21 EPS estimate, in line with the peer average and near the midpoint of the five-year historical average range of 11.8-22.2. We see some further near-term upside on continuing strong trends at Bath & Body Works and improvements at Victoria’s Secret. However, given the heavy sales declines at Victoria’s Secret and plans to substantially reduce the chain’s footprint, in addition to lighter store traffic the potential for further pandemic-related business restrictions, and weaker consumer spending, our rating remains HOLD.
On November 24, HOLD-rated LB traded at $38.98, down $1.00.