Photograph by Johannes Eisele/AFP/Getty Images
If the first step is admitting you have a problem, then
(ticker: LB) may have begun the process of fixing what caused its stock to lose more than half its value in 2018. Just don’t expect the stock to bounce anytime soon.
Last March in this space, we recommended that investors sell L Brands, despite the fact that the stock had already dropped 30% year to date. At the time, most analysts thought that fixing the company’s iconic Victoria’s Secret brand would be relatively easy. Now we know that something about Victoria’s Secret is fundamentally broken, as Jefferies analyst Randal Konik warned investors over two years ago.
This past week, L Brands admitted as much. On the company’s earnings call, L Brands CFO Stuart Burgdoerfer said in response to an analyst’s question that “everything is on the table” when it comes to rejuvenating the Victoria’s Secret brand. Among the actions it’s taking is closing 53 stores.
L Brands reported better-than-expected earnings—a profit of 6 cents a share versus Wall Street estimates of 2 cents—but offered dismal guidance. It expects to report a profit between $2.30 per share and $2.60 a share in 2019, below forecasts for $2.75. Same-store sales rose just 3%, despite heavy discounts. The company declined a request for additional comment.
There was a bright spot for bulls to focus on as they wait for change at Victoria’s Secret—namely, Bath & Body Works. Same-store sales at the unit rose 12%, double their rate during the same quarter in 2017. The bulls argue that with Bath & Body Works chugging along, and the stock trading at just 11 times 2019 earnings, investors are essentially getting Victoria’s Secret for free.
In fact, that was a big part of Barclays analyst Chethan Mallela’s decision to upgrade L Brands to Overweight from Equal Weight. “Executing on the Victoria’s Secret turnaround remains the single biggest multiple and sentiment lever for LB and we are increasingly comfortable with the steps management is taking to achieve this goal,” he writes. His upgrade of the stock on Friday helped shares of L Brands finish the week up 5.2% at $27.50.
Of course, it could go the other way. Bath & Body Works has been growing so fast for so long now that it will get harder to maintain the same rate, says Jefferies’ Konik. That ultimately means that it will disappoint investors hoping that it can continue to do the heavy lifting for L Brands. Margins at Bath & Body Works, now 23%, could also be unsustainably high, says Konik, who expects them to slip into the high teens by next year. “Bulls think Bath & Body Works is a great business that can grow into perpetuity,” Konik says. “That’s not the case.”
But the bigger problem remains Victoria’s Secret. Management is betting that new products will bring customers back into stores, but Konik argues that it’s not something that will be easily fixed by simply tweaking what it sells. The unit is losing market share to competitors new and old—think
American Eagle Outfitters
’ (AEO) Aerie brand and
(TGT) new Auden brand—and that will force it to offer even more discounts to compete.
“Victoria’s Secret is in structural decline,” says Konik, who has a $16 price target on L Brands shares. “The stock is going to be volatile, but the direction of the fundamentals is pretty clear.”
Yes, L Brands shares are down 37% since we suggested selling on March 3, 2018. But change takes time. We’re not ready to reverse our recommendation just yet.
Write toBen Levisohn at [email protected]