Looking at L Brands' Growth Drivers

In this article, let's take a look at L Brands, Inc. (LB, Financial), a $19.49 billion market cap company, which operates as a specialty retailer of women's intimate and other apparel, beauty and personal care products and accessories under various trade names.

Best Brands

The company survived 50 years and has built a well-known portfolio. The firm decided to divest in some brands, while key brands like Victoria's Secret and Bath & Body Works, are today's market leaders. They have popular brand recognition and are products with higher margins, too. Last year, sales per average selling square foot was $825 at Victoria's Secret and $764 at Bath & Body Works.

Expansion Outside the U.S.

We think it could expand and reach other markets apart from the top two brands. Additionally, some international markets could expand faster than nowadays, so it constitutes an interesting opportunity. This would prove the effectiveness of management to make a strategic approach to expansion outside the U.S. Management has shown good inventory policies and expenses management, improving them in recent years.

Franchise Model

The franchise model is characterized by allowing the control over its partners and this is very important in this type of business. Also, things related to prices or storing or promotions are under the umbrella of the model.

Revenues, Margins and Profitability

Looking at profitability, revenue growth by 6.31% led earnings per share to increase in the most recent quarter compared to the same quarter a year ago ($0.63 versus $0.61). During the past fiscal year, the company increased its bottom line. It earned $3.05 versus $2.54 in the prior year. This year, Wall Street expects an improvement in earnings ($3.20 versus $3.05).

Finally, let´s see a measure defined by Joel Greenblatt (Trades, Portfolio): the Return on Capital, which he analyzed it differently in his book “The Little Book That Still Beats the Market (Little Books. Big Profits).” He defined Return on Capital as EBIT divided by the total of net fixed assets and net working capital.

The formula is: Return on Capital: EBIT/(Net Working Capital + Net PPE – Excess Cash)

So, let´s compare the ROC which is one of the most important measures of the efficiency of a business and should be an important tool for investors.

The ROC is higher than 95% of the 1163 companies in the industry. L Brands has a current ROC of 76.99% which is the highest in the last 13 years and is also higher than the industry median.

During the past 13 years, L Brands Inc's highest Return on Capital was 91.27%, the lowest was 24.73% and the median was 54.52%.

It is very important to understand this metric before investing and it is important to look at the trend in ROC over time.

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 21.3x, trading at a premium compared to an average of 22.3x for the industry. To use another metric, its price-to-sales ratio of 1.79x is above the industry average of 0.79x.

Final Comment

As outlined in the article, Victoria's Secret dominates the intimate apparel market, with almost a third of the market share. Further, the company can have more room to focus on core brands, due to the divestitures of unprofitable businesses.

If we think about long term drivers, we believe that international expansion is an important area to exploit in the future. Moreover, it has gained international reach through franchise relationships.

The PE relative valuation and the return on equity that significantly exceeds the industry average and make me feel bullish on this stock.

Hedge fund gurus like Paul Tudor Jones (Trades, Portfolio) and James Barrow (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014, as well as Manning & Napier Advisors, Inc. and PRIMECAP Management (Trades, Portfolio).

Disclosure: Omar Venerio holds no position in any stocks mentioned