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L Brands Still Can't Fix Its Biggest Problems

By Leo Sun - Aug 23, 2019 at 2:30PM

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Victoria’s Secret continues to lose shoppers as Bath & Body Works loses momentum.

L Brands (BBWI -6.18%), the parent company of Victoria's Secret and Bath & Body Works, lost about 40% of its value over the past 12 months amid concerns about its lingerie brand's slowing growth. A dividend cut last December, a brief activist battle, controversial comments about transgender models, and ugly reports about Jeffrey Epstein's connections to Victoria's Secret exacerbated that pain.

L Brands' second-quarter report didn't allay those fears. Its revenue fell 3% annually to $2.9 billion, missing estimates by $50 million. Its adjusted net income plunged 32% to $67.3 million, or $0.24 per share, which still beat estimates by four cents.

A Victoria's Secret store.

Image source: L Brands.

Those headline numbers were ugly, but a deeper dive into the report indicates that L Brands still hasn't fixed its biggest problems: the slow death of Victoria's Secret, its dependence on Bath & Body Works, and its declining margins.

L Brands' biggest headaches

L Brands generated 55% of its revenue from Victoria's Secret during the second quarter. 37% came from Bath & Body Works, and the rest came from its other businesses, including the international operations of both banners. Here's how its two core brands fared over the past year in terms of comparable store sales growth:

Banner

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Victoria's Secret

(1%)

(2%)

(3%)

(5%)

(6%)

Bath & Body Works

10%

13%

12%

13%

8%

Total

(3%)

4%

3%

0%

(1%)

Comps growth, stores plus direct sales. Source: L Brands quarterly reports.

Victoria's Secret is struggling for two main reasons: declining mall traffic and tough competition from rivals like American Eagle Outfitters' (AEO -6.34%) Aerie. Aerie branded itself as the "anti-Victoria's Secret" with body-positive ads featuring untouched photos of models of all shapes and sizes, and that strategy made Victoria's Secret's ads and products seem oversexed and outdated. Aerie's comps rose 14% last quarter -- on top of its 38% comps growth a year earlier.

L Brands hired former Tory Burch president John Mehas as Victoria Secret's new CEO in late 2018, but none of Mehas' strategies -- including a swimwear relaunch, e-commerce upgrades, a new RFID tracking system (for tracking and analyzing purchases), and splitting Victoria's Secret and its younger brand PINK (led by CEO Amy Hauk) more clearly -- are moving the needle.

Bath & Body Works also failed to offset Victoria's Secret's declines, as it did in previous quarters, as its comps growth decelerated. During the conference call, executive VP and CFO Stuart Burgdoerfer claimed that Victoria's Secret would "improve", and that Bath & Body Works would "continue to deliver strong results." However, those statements are vague, and the company didn't offer any comps guidance for the third quarter or full year.

A Bath & Body Works store.

Image source: L Brands.

Meanwhile, L Brands' gross margin contracted both annually and sequentially during the second quarter, indicating that it's marking down more merchandise to boost its sales. Its operating margin fell annually, but rose sequentially -- indicating that it's cutting certain expenses (like marketing) as its growth slows.

Period

Q2 2018

Q1 2019

Q2 2019

Gross margin

35.5%

35.5%

33.9%

Operating margin

7.6%

5.8%

6%

Source: L Brands quarterly reports.

The turnaround efforts are too slow

Victoria's Secret's marketing chief Ed Razek, who was pilloried for his controversial comments about transgender models, recently announced his retirement after the company hired its first transgender model.

Burgdoerfer briefly acknowledged Razek's departure during the conference call, but stated that Victoria's Secret was working to achieve a "meaningful" and "thoughtful change" to its marketing approach for the fall and next year. However, the company also admitted that it cut Victoria Secret's marketing spending year-over-year during the quarter, and that it would focus on cutting operating expenses at the banner if its comps growth didn't improve.

Those statements don't inspire much confidence, since Victoria's Secret desperately needs a marketing makeover to counter Aerie and change its public image. Last year, viewership of Victoria Secret's annual fashion show -- a key gauge of public interest in the brand -- slumped to an all-time low.

Burgdoerfer told investors to expect a "significant amount of change" in the brand's fall assortments and promotions, but also warned about uncertainties regarding tariffs. Once again, those statements were vague and didn't indicate that L Brands' bleeding would stop.

The only bit of guidance L Brands offered was for its earnings growth. It expects its third-quarter earnings to come in at $0.00 per share (at the midpoint), compared to an EPS of $0.16 a year earlier. For the full year, it expects its adjusted EPS to decline 8%-18%.

Don't be tempted by its low valuation and high yield

L Brands' low forward P/E of 8 and high forward yield of 6% might look tempting, but it's cheap for obvious reasons -- its top brand is fading, its margins are declining, and its turnaround efforts are stuck in the mud. Investors should stay away and invest in more promising retail plays like American Eagle instead.

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Stocks Mentioned

Bath & Body Works, Inc. Stock Quote
Bath & Body Works, Inc.
BBWI
$36.15 (-6.18%) $-2.38
American Eagle Outfitters, Inc. Stock Quote
American Eagle Outfitters, Inc.
AEO
$12.11 (-6.34%) $0.82

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