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1 Retail Stock to Avoid No Matter What

By Adria Cimino – Aug 28, 2020 at 1:03PM

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This struggling retailer faces too much uncertainty to make it a good buy today.

Before the coronavirus spread throughout the U.S., things were looking up for L Brands (BBWI -4.95%). Private equity firm Sycamore Partners had agreed to take on a majority stake in the company's struggling Victoria's Secret brand. That meant L Brands could focus on the booming business at its other chain, Bath & Body Works.

Two women look at lingerie inside a glass case in a store.

Image source: Getty Images.

Two months later, Sycamore decided to cancel the deal. The silver lining in this grim news is that L Brands still is moving forward with its plan to separate the two brands. The goal is to make Bath & Body Works a pure-play public company and establish Victoria's Secret as a stand-alone business. L Brands has even hired Goldman Sachs and J.P. Morgan to explore options.

Though that's positive, L Brands remains a retail stock I would avoid. Let's take a closer look.

The holiday season

First of all, an announcement about Victoria's Secret's future isn't imminent. In its recent earnings call, L Brands said it would look to results from the holiday season to value the business. If the company sticks to that, we shouldn't expect any news until at least early next year. That means results from Victoria's Secret will continue to impact earnings for the foreseeable future. In the second quarter, Victoria's Secret total sales in the U.S. and Canada slid 39%. If we look at only the period when stores were open, same-store sales fell 10%.

That said, L Brands is making efforts to improve the situation at Victoria's Secret while it seeks a long-term solution. The company has already worked on managing inventory, lowering receipts by 45% in the spring compared to the same period last year. It expects fall inventory receipts to be down by 50%. The retailer also is closing 250 Victoria's Secret stores this year, including its unprofitable flagship store in Hong Kong. L Brands expects these and other measures to result in annualized cost savings of $400 million -- and $175 million of those savings will happen this year.

Still, the outlook for the rest of the year doesn't give investors a reason to cheer. L Brands makes most of its annual profit and sales during the fourth quarter. And this year, due to social distancing measures in stores and limits on capacity in distribution centers, L Brands said it's "very cautious" about how it will manage volumes during the holiday shopping season. The company also predicts higher costs at stores due to social distancing. That will result in "meaningful expense pressure," L Brands said.

A bumpy near term

So, the near term could be bumpy for L Brands. But what about the long term? We are long-term investors, after all. L Brands is moving in the right direction by cutting costs and seeking to separate its two businesses. A possible sale of all or a majority stake in Victoria's Secret would clear the way for L Brands to progress with Bath & Body Works, its primary revenue-generating business. Even during the coronavirus crisis, total Bath & Body Works sales in the U.S. and Canada rose, climbing 13% in the second quarter. So right now, moving toward a pure-play scenario sounds good.

But can Bath & Body Works keep up the revenue growth in the years to come? The stores are often located in malls, which are struggling. And social distancing may weigh even more on foot traffic in malls through the coronavirus crisis and possibly beyond. The brand also faces competition online and in store from chains like Ulta Beauty (ULTA -1.09%) and LVMH Moet Hennessy's Louis Vuitton (LVMUY -0.74%) and Sephora stores. 

At this point, there is too much uncertainty regarding the fate of Victoria's Secret and the future of Bath & Body Works to take a position in L Brands' shares, especially considering the recent share-price performance. L Brands has soared 203% since its March low. And the stock is trading just above Wall Street's average 12-month price target. Considering the uncertainty and recent share gains, long-term investors are better off staying away from this retail stock.

Adria Cimino has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Ulta Beauty. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Bath & Body Works, Inc. Stock Quote
Bath & Body Works, Inc.
$33.63 (-4.95%) $-1.75
LVMH Moët Hennessy - Louis Vuitton, Société Européenne Stock Quote
LVMH Moët Hennessy - Louis Vuitton, Société Européenne
$119.20 (-0.74%) $0.89
Ulta Beauty, Inc. Stock Quote
Ulta Beauty, Inc.
$404.76 (-1.09%) $-4.45

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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