L Brands Inc. (NYSE:LB) is the name, but we’re much more likely to know its starring segment: Victoria’s Secret. Anyone who’s spent time in a shopping mall is likely to recognize the other segments in L Brands' operations: PINK (a component of Victoria’s Secret), Bath & Body Works, La Senza (another intimate apparel retailer) and Henri Bendel, a small retailer of handbags, jewelry and accessories
The company has had a sterling growth record since its founding more than 50 years ago, but internal restructuring and weak earnings guidance early this year sent its share price tumbling down as we see in this three-year chart:
PJ Pahygiannis summed up the problem this way,
“On Feb. 24, LB announced weak earnings guidance. It also forecasted 'negative impacts related to continued pressure from foreign currency exchange rates and incremental interest expense related to the $1 billion October 2015 note issuance.'"
The dip that followed has put L Brands on the Undervalued Predictable screener at GuruFocus, and a candidate for speculation about a comeback.
History
1963: Les Wexner opens The Limited store in Columbus, Ohio.
1976: The company opens its 100th store.
1982: Listed on the New York Stock Exchange.
1982: For $1 million, the company buys Victoria's Secret, comprising six stores and a catalog.
1990: Bath & Body Works opens its first store, in Boston.
2003: Makes its first appearance in Fortune magazine's most admired companies.
2013: Company name changes to L Brands, and the stock ticker changes from LTD to LB.
History based on information at the company website.
Comments: Although not shown in this history, the company has bought and sold several companies, and its stable of companies now focuses on intimate apparel, personal care and beauty products as well as apparel and accessories.
L Brands' business
Through some 3,000 of its own stores and 1,000 franchised stores, the company sells multiple major brands, including the iconic Victoria’s Secret. On its website, L Brands describes itself this way:
“Although we are primarily known for the lingerie, personal care and beauty products and accessories we sell, our power as brands extends much further. Together and individually, these brands have come to represent an aspirational lifestyle — a way of life. Our brands help customers feel sexy, bold and powerful.”
Its stores and websites feature four major brands:
- Victoria’s Secret, including PINK: a specialty retailer of women’s intimate and other apparel.
- Bath & Body Works: a specialty retailer of personal care, soaps, sanitizers and home fragrance products.
- La Senza: a specialty retailer of women’s intimate apparel.
- Henri Bendel: a retailer of handbags, jewelry and other accessory products.
(Unless otherwise noted, information in this section is based on the company’s 10-K for 2015).
Franchise, license and wholesale arrangements provide a significant portion of the company’s revenue and earnings. As of Jan. 30 franchisees operated 738 stores selling Victoria's Secret, Bath & Body Works and La Senza products globally. Most of the income from these sources is in the form of royalties.
The business is seasonal, with the fourth quarter, including the holiday season, bringing in about one-third of net sales; it is usually the most profitable quarter. Cash requirements are highest in the third quarter for inventory build.
Operations are divided into three reportable segments:
- Victoria’s Secret.
- Bath & Body Works.
- Victoria's Secret and Bath & Body Works International.
Comments: A specialty retailer focused on intimate apparel and related products; the company has a growing footprint in both the U.S. and international markets. It is seasonal with the holiday season making the fourth quarter the busiest of the year.
Revenue
As this graph from CSIMarket shows, Victoria’s Secret and Victoria’s Secret Stores represent the biggest share of L Brands' revenue:
Geographic origins of revenue: Vault.com reports that approximately 3,000 of its stores are domestic, which leaves about 1,000 in the international market. It also reports that international sales for fiscal 2015 brought in about 11% of the company’s total revenue.
Comments: A good mix of revenue sources embracing several different lines and a reasonable amount of international revenue.
Competition
L Brands says of its competition:
- Brick and mortar: "The sale of women’s intimate and other apparel, personal care and beauty products and accessories through retail stores is a highly competitive business with numerous competitors including individual and chain specialty stores, department stores and discount retailers."
- Online: "Our online businesses compete with numerous online merchandisers. Image presentation, fulfillment and the factors affecting retail store sales discussed above are the principal competitive factors in online sales."
While no other company has a presence in intimate apparel like Victoria’s Secret, a Motley Fool article from 2013 lists American Eagle's (NYSE:AEO) Aerie brand and Abercrombie's (NYSE:ANF) Gilly Hicks as increasingly competitive in that space.
Comments: Competition for L Brands, and particularly Victoria’s Secret, comes from thousands of traditional and online stores.
L Brands’ Moat
In its 10-K, L Brands reports, “Brand image, marketing, design, price, service, assortment and quality are the principal competitive factors in retail store sales.”
Bridget Weishaar of Morningstar offers four reasons why L Brands deserves wide moat recognition:
- “We are maintaining our wide moat rating for L Brands as we continue to believe that the strong Victoria’s Secret and Bath & Body Works brands can command a relatively sustainable consistent pricing power. There is a limited amount of direct competition of Victoria’s Secret’s scale in women’s lingerie retailing, with Gap (GPS, Financial) and Aerie at a lower price point and brands like La Perla at a much higher price point. Similarly, Bath & Body Works has been able to maintain its lead over its nearest competitor, The Body Shop, and we don’t see this changing.”
- “A competitively differentiated intangible asset. Victoria’s Secret is the No. 1 brand in dollar share for bras and panties. It has three of the top 10 fragrances in the U.S. in the form of Bombshell, Heavenly and Tease.”
- “We view gross margin as one of the most important metrics reflecting brand strength, as this value conveys not only pricing strength but also the ability to sell at full price.”
- “The company has significant cost advantages versus its competitors. Investments in its supply chain have yielded impressive levels of inventory discipline. On average, lead times have been reduced by 50%, and we think there is an opportunity for a further similar reduction.”
The company provides this overview in its 2016 Investor Handout:
Comments: According to the experts at Morningstar, pricing power, product differentiation, gross margin and cost advantages give L Brands a moat that will protect it from competitors for years to come.
Growth
The following 10-year chart shows L Brands' revenue growth. Note the impact of the recent financial crisis on that revenue:
Looking forward, L Brands posts this overview of its growth plans in this slide from the 2016 Investor Handout:
Comments: With the exception of the financial crisis years, L Brands has powered its revenue higher. It plans more of the same with brand reinforcement, new products, speed of product development and delivery, store selling initiatives, increasing store size, online growth and international growth.
Other
L Brands is incorporated in Delaware and headquartered in Columbus, Ohio.
Chairman of the Board and Chief Executive Officer: Leslie Wexner, age 78, the founder of the company.
Chief Financial Officer and Executive Vice President: Stuart Burgdoerfer, age 53.
Fiscal years end on the Saturday closest to Jan. 31. Its most recent fiscal year ended on Jan. 30.
It employees 87,900 staff, 65,000 of them part time.
Information about the officers from Reuters.com; other information from the 10-K for 2015.
Ownership
Seven of the investing gurus followed by GuruFocus have L Brands holdings. PRIMECAP Management (Trades, Portfolio) leads the pack with 16,188,451 shares. Barrow, Hanley, Mewhinney & Strauss has the second-largest holding while Murray Stahl (Trades, Portfolio) has the third largest.
This overview of L Brands' ownership shows a strong presence of institutional investors with low interest among shorts and a small holding by insiders:
While the insider holdings are relatively small, founder Leslie Wexner is strongly committed with 16,225,148 shares as of May 18. That’s slightly more than the holdings of PRIMECAP Management (Trades, Portfolio) as noted above and represents 5.67% of outstanding shares.
Comments: In keeping with its size and influence in the retail sector, L Brands enjoys strong support from institutional investors; founder and current CEO/Chairman Wexner continues to have a major stake in the company’s fortunes.
L Brands by the numbers
Comments: Price is nearing the midway mark between the 52-week high and low; the price-earnings (P/E) is modest; it pays a good dividend with a safe payout ratio; and last year it bought back a small portion of its outstanding shares.
Financial strength
L Brands receives a mediocre 5 out of 10 for financial strength and a strong 8 out of 10 for profitability and growth in the GuruFocus system:
At least one reason for the poor showing on financial strength is immediately obvious: the debt situation, specifically Cash to Debt and Equity to Assets have deteriorated from where they were in the past. In addition, Interest Coverage has weakened as well, but not as seriously.
Before going further, we should note the strong WACC vs ROIC ratio; the company is making very good use of the capital that’s made available to it.
Let’s look at L Brands' long-term debt in this one-year chart.
Obviously, a significant increase in debt, but let’s also look at L Brands' earnings over the same period.
Earnings have risen with the debt load, and the same holds for free cash flow, also shown on a 10-year chart.
A bumpier chart, but free cash flow has grown along with the other metrics we’ve considered.
Interestingly, this is one of the few stocks in the GuruFocus universe that has only positive warning signs (including a good Piotroski F-Score):
Back to the debt issue: Black Coral Research has this comment in a Seeking Alpha article:
“If anything, the main concern in terms of L Brands' balance sheet is its high degree of leverage, which exceeds that of its industry. For this reason, L Brands is considered a sub-investment grade credit. Its history of share repurchases and special dividends have effectively siphoned-off its earnings and the company has recapitalized itself through debt.”
Comments: L Brands’ debt has grown over the past few years, as it appears to have chosen to both maintain growth and reward shareholders at the same time.
Valuation
L Brands is a 4-Star (out of 5) stock, which makes it part of an elite group in the universe of all publicly traded stocks. GuruFocus backtesting has found that the more predictable the earnings, the higher the odds of long-term gains and the lower the risk of losing money over a ten-year period.
Turning to valuations GuruFocus recommends, “L Brands Inc is more suitable for earning power based valuation methods. This includes 1) median price-sales (P/S) value and 2) Peter Lynch Fair Value. The median P/S value of L Brands is 50.44. The Peter Lynch Fair Value of L Brands is 43.66.” Both seem unrealistically low.
The following five-year chart shows L Brands’ P/E in historical context, sitting at the low end of the range established over the past five years:
In addition, it’s slightly below the median P/E of its peers:Â “NYSE:LB's P/E Ratio(ttm) is ranked higher than 59% of the 777 Companies in the Global Apparel Stores industry. (Industry Median: 20.84 vs. NYSE:LB: 17.89 ).”
The PEG ratio (P/E divided by earnings growth) also falls in the middle of the Global Apparel Stores pack, at 1.70. This score puts it near the high end of the fair value range (1.0 to 1.9).
A ModernGraham valuation published July 30 came to this conclusion:
“L Brands Inc. is suitable for the Enterprising Investor, but not the more conservative Defensive Investor. The Defensive Investor is concerned with the low current ratio, high PE mg and PB ratios. The Enterprising Investor is only concerned with the level of debt relative to the net current assets.”
On the Undervalued Predictable screen, we see the share price is 27% under-valued under Discounted Cash Flow and over-valued by 6% under Discounted Earnings.
Here’s a look at price action over the past 5 years:
Comments: The valuations come in over a wide range, but given how far the price dropped on relatively minor news, I’m inclined to think the share price is on the low side of fair valuation, and that its P/E in relation to its own history and its peers is a good reflection of that.
Conclusion
How much do you dislike long-term debt? If you don’t like it you will want to shy away from L Brands which has used it quite aggresively over the past few years.
If you’re less concerned, you might look at how L Brands uses its capital, with a strong WACC vs. ROIC ratio (Weighted Average Cost of Capital vs Return on Invested Capital). The company obviously manages its capital well and has used debt to pay a good dividend, special dividends, and buy back shares while maintaining its growth.
L Brands has a recognized wide moat that should allow it to keep growing its top and bottom lines, leading to share appreciation and as noted dividends plus occasional special dividends.
The company is slightly undervalued at the current price and worth adding to your short list if you’re looking for a company with growth and returns to shareholders, while reasonably tolerant of long-term debt.
Disclosure: I own no shares in any of the companies listed in this article, nor do I expect to buy any in the foreseeable future.
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