L Brands’ Price Estimate Revised To $89 On Continuous Better-Than-Expected Performance

The parent company of Victoria’s Secret and Bath & Body Works, L Brands (NYSE:LB), has performed exceedingly well in the U.S. and abroad amid an edgy retail environment. Its niche image and strong footing in the intimates and personal care industry have been the main driving factors behind the overwhelming customer response, which  has contributed strongly to the company’s better-than-expected growth quarter after quarter. Backed by its sturdy growth and promising outlook, L Brands’ stock has increased by almost 70% over the past year and we have raised our target price for the company to $89, up 15% from our previous estimate of $77.

The retailer isn’t short of growth drivers and its sturdy performance is likely to continue in the future, now that it has effectively bolstered its weakest link — Victoria’s Secret’s direct business. The brand’s mainline stores have delivered steady positive results over the past several years irrespective of the macro-economic scenario, which paints a pleasing picture for its future. The health and personal care market in the U.S. is growing at a strong pace, and Bath & Body Works is at its forefront. The company’s performance has been pleasing on the international front as well, and we expect it to sustain this momentum as it enters new markets and expands in the existing ones. In this analysis we explain the changes we have made to our forecasts, which has resulted in a change in our price estimate.

See our complete analysis for L Brands

Victoria’s Secret’s Direct-To-Consumer Revenues Likely To Increase Rapidly

The last couple of years were extremely tough on Victoria’s Secret’s direct-to-consumer business, due to under-performance of its apparel and absence of shipping and handling revenues. When the entire apparel industry was struggling due to the change in consumer spending patterns, even Victoria’s Secret’s apparel products felt the impact, while its intimates were moving swiftly. However, L Brands proactively categorized its portfolio into “go forward” and “non go forward” and began clearance sales of the latter, which further impacted the channel’s growth. In 2013, the segment’s revenues fell 4.8% and they shrunk further by 0.6% to $1.5 billion in 2014. We expect that as soon as Victoria’s Secret completes the phasing out process of “no go forward” products, increase in sales of its “go forward” products would get direct-to-consumer channel’s growth back on track. We had earlier forecasted direct revenues to increase at a compound annual growth rate of 6.8% for the next six-seven years. However, looking at L Brands’ decision to exit apparel altogether and the continued strong growth in intimates and beauty business, we have revised our forecast to a CAGR of 10%. Given Victoria’s Secret’s strong product portfolio and its vast customer reach, it looks strong enough to achieve this growth.

Bath & Body Works’ Revenue Per Square Feet Growth Will Be Better

Bath & Body Works‘ has been growing strongly for a while now, thanks to the success of its core categories: the signature collection, soap & sanitizer products, and home fragrance. In fact, the U.S. personal care industry itself has performed extremely well lately. Last year, the health and personal care market grew 6% and it increased by a similar amount during the first three months of 2015. Though a part of this growth may have come from the health care industry, we believe that buyers have started spending more on personal care products as well. This paints a pleasing picture for a player as strong as Bath & Body Works, who would not be short on growth any time soon. Our earlier projections for Bath & Body Works’ revenue per square feet growth was at 3.5% (CAGR), but we have now revised it to 5%. We have even raised the brand’s direct-to-consumer revenue growth outlook slightly.

Capital Expenditure Growth Would Not Be As Intense

L Brands is an established player in the U.S. with over 2,700 stores in North America across all its brands. Since the company has such a huge presence, it makes sense to slow domestic expansion down and focus on international growth and direct-to-consumer expansion instead. In international markets, the company is mainly looking to expand with franchise partnerships that does not require much upfront capital. On the direct-to-consumer front, L Brands is already well established and new projects in this arena require a relatively lesser capital as compared to medium-scale store expansion. Although Victoria’s Secret’s opened 94 stores in the last two years, most of them were attributable to the PINK brand, which the company may look to expand steadily over the coming few years. However beyond that, we believe that the expansion will be slow as the present retail scenario provides more incentives for investments in the e-commerce space. For Bath & Body Works, L Brands is actually consolidating the store network, because it had earlier expanded the brand to over 1,600 stores in North America. Therefore, we believe that the company’s capital requirements in the future will be mostly related to e-commerce investments and hence, we have scaled back our estimates for capex. Our earlier forecast indicated that L Brands’ total capex will increase at a compound annual growth rate of 4%, which has now been revised to 3%.

The cumulative effect of the aforementioned changes has brought about 15% upside to our price estimate for L Brands, which is now in line with current market price.

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