L Brands Recovery in Progress, Shares Cheap
With recovering comparable sales pointing to intact brand strength, the stock price is unjustified.
Although wide-moat L Brands (LB) still has work ahead, we believe that improving comparable sales growth throughout fiscal 2017 (from a 9% decline in the first quarter to 2% growth in the fourth quarter) and easing gross margin pressure (from a 280-basis-point decline to 37.1% in the first quarter to a 100-basis-point decline to 42.3% in the fourth quarter) point to a recovery in progress. We continue to believe that L Brands can return to comparable sales growth in fiscal 2018 and that gross margin pressure will ease with the comping of swim and apparel exits and mix challenges. We are modeling 1% revenue growth and a 20-basis-point decline in gross margin to 39.1%. Full-year guidance for 4% to 6% sales growth, including the benefit of reclassifying Angel card income, and flat gross margin further supports our thesis. Therefore, we see little change to our $69 fair value estimate outside of the time value of money and the impact of $100 million in incremental wage investments. With recovering comparable sales pointing to intact brand strength, we think the current discount to our fair value is unjustified and view this as an attractive entry point for investment.
Victoria’s Secret, 55% of fourth-quarter revenue, is still a work in progress, but pockets of light can be seen. Fourth-quarter comp sales decreased 1%, including a 6% decline in store comps. Digital sales performed well, up 20%, while bra initiatives showed traction with an increase in constructed bra comps and total bra average unit retail. That said, product resets are needed for “3 for” and single-ticket panties as well as Pink loungewear. We feel that our estimates calling for flat average annual revenue growth in this segment over the next five years adequately accounts for secular brick-and-mortar traffic headwinds offset by product improvements.
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Bridget Weishaar does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.