Earlier this summer, I raised questions about the sustainability of L Brands' (BBWI 0.30%) dividend, given the company's deteriorating profitability in this new age of retail and its surging debt load.
Sure enough, L Brands just decided to cut its annual dividend in half, from $2.40 to $1.20 per share. At the current stock price, that gives the stock a yield of about 3.5%. In addition, management decided to close down its smaller Henri Bendel high-end cosmetic brand, while pursuing "strategic alternatives" for its small La Senza subsidiary. That's a way of saying the company is looking to sell the subsidiary. The company also announced management changes at Victoria's Secret, the company's largest brand.
Now that the proverbial bandage has been ripped off, is the stock compelling?
L Brands cuts its dividend. Image source: Getty Images.
A positive mirage of a quarter
At first glance, L Brands' third-quarter results don't seem so bad. Revenue increased 5.7%, with same-store sales growing by 4%. In addition, the company raised its full-year adjusted earnings-per-share estimate from between $2.45 and $2.70 to between $2.60 and $2.80.
So what's wrong? Several things. First, revenue growth may not be as good as advertised. L Brands began employing a new accounting standard this year, which will have the effect of inflating revenues relative to last year...as well as costs. The company's margin picture looks much uglier, with adjusted operating income falling to $155.6 million from $231.7 million in the year-ago quarter -- a 33% decline.
And while the current quarter's guidance may be positive relative to recent guidance, the current full-year guidance is still below the guidance of $2.95 to $3.25 given at the beginning of 2018.
Investors are also right to worry what might happen when the economy starts to sour.
Victoria's not-so-secret struggles
Also worrying investors: While the company's Bath & Body Works brand is growing strongly, the company's core brand, Victoria's Secret, deteriorated, showing a 6% drop in comps.
|
Brand |
Q3 Same-Store Sales Growth (stores and online) |
Q3 Store-Only Same-Store Sales Growth |
% of Company Revenues |
|---|---|---|---|
|
Victoria's Secret |
(2%) |
(6%) |
55.1% |
|
Bath & Body Works |
13% |
10% |
34.4% |
Source: L Brands Q3 2018 press release.
Since Victoria's Secret is struggling and makes up the largest percentage of revenues, I wouldn't expect overall company metrics to rebound anytime soon. And while Bath & Body Works is growing strongly, it's unclear to me how fast any consumer retail brand can continue to grow by double digits. If Bath & Body Works slows down for any reason, things could get even worse.
Changes at the top
In response to these challenges, L Brands announced it would be replacing Jan Singer, the CEO of the Victoria's Secret segment, with John Mehas, from lifestyle brand Tory Burch. The changes at the top continue the trend for L Brands, which also replaced the CEO of Pink, the casual sub-brand under Victoria's Secret, this past summer.
Victoria's Secret has been late to the game in addressing societal pressure to showcase more diverse models, upstart competitors that offer cheaper alternatives, and digital innovation. At the same time, Pink has suffered from recent product innovations that haven't panned out. On the recent call with analysts, the company admitted that Pink "didn't get paid" for expensive product changes, leaving expensive inventory to be cleared.
Staying on the sidelines
With the roughly $325 million the company will be saving by cutting the dividend, L Brands plans on not only paying down debt (which I salute, given the huge $5.7 billion-plus debt load), but also doubling its investment in digital commerce, which the company claims is growing at a "healthy rate," and has operating margins north of 20%.
However, Victoria's Secret appears to be late to the game, only now looking to replatform the business to enable features many other retailers have, such as the ability to order online and pick up in store and other omnichannel initiatives. In addition, the company is still stuck with retail stores that continue to lose traffic. Given that retail leases are often 10 years or longer, the company won't be able to close stores as quickly as it might like.
While management seems to be doing the right things, retail is a tough business. No matter how skillful new management is, it's uncertain that Victoria's Secret can turn around, or that Bath & Body Works can continue its current rate of growth. I'm still staying away.
