LB preannounced its 4Q comps with an upward revision in earnings alongside the announcement that the CFO will be retiring in August. VS reported 4Q comps of -3% accelerating significantly in January as Holiday was was down 9%. Business are trends improving heading into very easy comparisons in 1Q. BBW also accelerated with comps of 22% for 4Q up from 17% during holiday. Remember that BBW also had doors closed in peak pandemic shutdowns of spring 2020, so the reported 'comp' might look hard to beat, but lapping the door closures means revenue growth is about to accelerate there as well. 4Q EPS was revised up to ~$3.00 or up 60% yy. So we have a company growing EPS at 60%, revenue trends accelerating into easy compares, and a coming catalyst of separating the businesses that means the market should assign appropriate EBITDA/sales multiples unlocking value.
We think that looking at these 2 businesses separately means fair value for LB of $65-$70 per share or ~50% upside. Bull case upside to $90, +100%.
Below is our valuation framework and note adding LB to our Best Ideas Long list.
In calculating the sum of the parts, we’ve assumed International to have no value, the separation has a dis-synergistic impact of $1bn in EV, 45% of D&A allocated to BBW, and 25% of leases counted as debt given potential need to further exit leases (lease penalty).
Our Note From 1/25/21
LB | New Best Idea Long. 50%-60% Base Case Upside
Takeaway: The market is currently valuing VS at close to zero, but the market will recognize its fair value within 6 mos. Bull case upside = double.
We’re adding LB to our Best Idea Long list. While the stock has worked over the past year, from where we sit the call is far from over and the catalysts are lining up for a run in this name over the next 6 months. LB has two businesses -- Victoria's Secret and Bath & Body Works. One is one of the most recognizable brands in all of apparel, the other is sneakily one of best retail boxes in the market today. Victoria's Secret has seen a massive fall from grace being late to recognize some changing consumer preferences, losing share to Aerie, and being plagued by constantly elevated levels of discounting. Now we think the bottom is in for VS and the company has taken the pandemic as an opportunity to clean up the business, reduce inventories and discounting, adjust real estate exposure and costs, and align for healthier growth. On the BBW side we think concerns for it ‘comping the comp’ are over blown. We see the impending separation as a clear way to unlock value for the LB businesses. With our view of the separation catalyst and the trend in the businesses, we see fair value today at $65-$70 or 50-60% upside. If the market wants to give both of these businesses a full Quad2 kind of multiple there is upside to $90 or a double from here.
Bath & Body Works
The business has been an incredibly consistent performer for having half its store base inside malls. It was a winner in the pandemic, selling a lot of hand sanitizer, soap, lotion, etc. But we think any bear case around this being unable to lap Covid would be false. The items that BBW sells are ones that are rapidly depleted. Unlike other categories that have outperformed in the pandemic (electronics, sporting goods) where the replacement cycle is long, the items BBW sells don’t last, so it's difficult to have a real pull forward of demand. People being at home may also consume more candles, but people are going to be home much more in 2021 than they were in 2019 (let's hope not as much as 2020). The other considerations are that the pandemic is not over, so we expect share wins to remain with the winners for several more months as least, and as we think about the relevant categories post pandemic, a substantial supply of hand sanitizer is likely to be a staple of the average purse and vehicle glovebox for upwards of a generation. These behaviors will stick. Let's also not forget, that BBW saw plenty of closed store days in the pandemic, so compares are about to get very easy for a multi month time period. Meanwhile, BBW has been able to deliver solid sales trends with traffic to retail centers being decimated. We think traffic starts picking back up for the other retailers in the mall around mid-2021, so when comps get tough for BBW you'll have a lot more impulse buying vs last year at BBW from foot traffic recovering for shopping centers. Lastly, of course, stimulus and enhanced unemployment mean some boost to sales trends for the coming months.
Victoria's Secret
Not too long ago VS was a $6bn brand with mid-teens operating margin. We're not saying that’s where its headed back to, but as we look at the value of LB in total, it appears to us that the market is assigning essentially no value to the brand. It's still one of the most well known brands in US apparel. Losing relevance? Absolutely, but far from dead. As we look into 2021 it of course has easy compares facing store closures and crashing apparel demand during the pandemic. The category for VS itself should have a consumption tailwind as imports of bras were down 18% YY through November 2020. We expect there to be a snap back in work/dressy/occasion wear that was almost unneeded in 2020, and VS would certainly fall into that category. With the company lapping down ~40% sales rates from 1H2020 and our expected snapback in apparel demand by 2H2021, revenue trends for VS in 2021 are decidedly rate of change bullish. The company has taken the pandemic as a chance to really reset the brand, reduce inventory and promotions, get back to great product and messaging at the same time it's been closing bad stores and pushing back on landlords for better rents. If there is any retailer that has bargaining power, it's LB, as it has many mall stores. So we think margins are likely to be significantly improved as revenue accelerates.
How to Get Paid
The acceleration in revenue and profits in the coming months should get you some multiple expansion and likely upside to street numbers. But we think the real value creation will be from the coming separation, when the market will have to start to think hard about how to value these as two separate companies. We don’t know if an outright sale or spin is coming (if it can be done soon, we'd suggest the latter), but we do expect something in the next 6 months, and both have significant upside from the current stock price from where we sit. Both businesses will be accelerating and likely beating expectations leading into the separation. The deal will generate cash to reduce the debt burden allowing BBW to get the full multiple it deserves. We think given the profitability, defendability, and consistent performance of BBW, it should get a multiple like that of ULTA, off price retail (TJX), and perhaps even COST. That to us means and EV/EBITDA multiple around 15x-16x, no lower than 11x, and upwards of high teens. For VS, it's much harder to say, given how depressed margins are we probably have to look at sales multiples. When the company was forced to raise cash with its Sycamore deal a year ago, VS was valued at about 0.2x sales. Given the reset under Covid, and frankly the vastly different retail multiples in today's market, 0.2x is too low. We think 0.4x-0.6x is fair, some other mall connected companies we'd consider weaker long term businesses like FL or GPS are trading at or above that. We see upwards of 0.8x as very plausible. At the higher end of those multiple ranges, which is where retail has been trading in the Macro Quad2 environment, it would mean LB stock upside to $90 or 100% upside from current levels. We think mid-range fair value is $65-$70 or 50-60% upside. If we're very wrong, VS is worthless and BBW gets a below peer multiple, we think your downside is ~$35 or -20% from here. That risk reward we really like here with the positive rate of change and a separation catalyst ahead.
