L Brands (NYSE:LB)

Quick look at L Brands:

• Owns 2 major brands: Victorias Secret (underwear) and Bath & Body Works (like Body Shop).  
• 2/3rd of operating profit is from Victoria's Secret, 1/3rd from B&BW.  
• 97% of profits from US & Canada.  They have only recently started expanding e.g.: opened flagship stores in China and Singapore last year.
• While B&BW has been growing, Victoria's Secret has suffered declining sales in the past 2 years, causing their stock price to drop almost 50%.  Last week they reported their first positive monthly comparable-sales number in ten months, driving the stock up 8%.

Competitive Position

They are the largest player in the US: IBISWorld estimates they have over 60% of the lingerie market, Bernstein gives around 30% of the women's underwear market (and increasing).

Victoria's Secret is in the mid-to-slightly-expensive range.  They sell at the $35-50 price point, compared to:

• La Perla ($100+ to $700) range
• Gap ($17-$70)
• Target ($10-20)
• Walmart ($8-15)
• Amazon's Iris & Lilly brand ($10) - at these prices, Amazon is not competing with VS.

Changing fashion and Trends

Bralettes - a cheaper bra with no wiring - have become popular recently, hurting VS's profits.  However these are only suitable for B-cups and below.

A major competitor is American Eagle's Aerir brand.  Its aimed at teenagers, and rather than the airbrushed model look, they have the girl-next-door look.

Aerie has has has 15-25% quarterly same-store sales growth for the past 5 quarters.

Source: eMarketerRetail

Victoria Secret's competing brand, Pink, is also growing, but at a lower rate.  Their Annual Report states "low double-digit sales growth over last year" (not same-store sales).   So Aerie is beating them.

Can this industry be disrupted by online competitors, especially when it comes to offering a better fit and greater variety?  I would guess not, but who knows?

The Numbers

L Brand's profits dropped in 2016 and 2017:

Profit breakdown:

Because the "COGS, Buying and Occupancy" costs are one line on the income statement, we can't model their operating leverage (e.g.: An x% drop in sales leads to a > x% drop in profits, due to fixed costs - mostly rental).

ROE is meaningless because the company has long periods of negative shareholder equity!  Due to share buybacks and dividends, leaving minimal retained earnings.  Shares outstanding have steadily decreased:

Debt is a bit higher than I'd like, at around 6X projected 2017 earnings.  Its also been increasing:

I don't like the way they have borrowed in order to buyback shares and pay dividends.  Smells like financial engineering.  But they are still safely able to pay the interest.

Most of it is fixed rate debt:

    Source: Company presentation

Off-balance-sheet liabilities look OK: Negligible operating leases at 12m.  104m of real-estate guarantees as contingent liabilities. 

Conclusion

Buying this is a bet that their 2-year losing streak is over and same-store-sales keep recovering.  I'm betting on this because of VS' long history of growing market share, and I think that selling high-priced lingerie online will be difficult.

The stock is cheap, and a recovery is not priced in.  Its trading at 13X trailing earnings, and 20X projected 2017 earnings - trough earnings, hopefully.  I think it should trade at 15 to 20X earnings.  I think the US economy will be strong over the next few years.

I don't want to hold a retail company for years, due to recession risk and changing consumer trends.  If same-store-sales and earnings increase over the next year, the stock should be re-rated, and I'll sell.

Misc

• Goldman and Conde Nast 2017 survey: Victoria's Secret among top brands for millennials.