The news just keeps getting worse for Victoria’s Secret owner L Brands Inc (NYSE:LB). LB stock is down more than 40% so far in 2017, a poor performance even by the standards of the struggling brick-and-mortar retail industry. L Brands stock, in fact, hit a five-year low last month, before a modest rebound over the past few weeks.
That rebound has come to a quick end, with LB shares off nearly 5% so far today after Cowen and Company downgraded the stock to “neutral” on Wednesday. Anaylst Oliver Chen — a long-time bull on LB stock — cited falling bra prices as a major headwind going forward.
That’s not the only headwind facing L Brands stock, however. Profits and sales are falling, and the key Victoria’s Secret brand looks poorly placed in the current environment.
Cowen’s reversal from bull to bear might seem a bit late to some. But from here, it looks like a case of “better late than never.”
A Bra (And Panty) Problem for L Brands
The argument from Cowen on bra pricing is supported by recent L Brands results — and by looking at the industry as a whole. According to the company’s second quarter conference call, bra units sold in the quarter were up mid-single-digits year-over-year. But bra revenue declined high-single-digits on the same basis.
The implication is that unit pricing declined at least 10% – and possibly closer to 15% – in the quarter. That is a problem both for sales – but moreso for margins. Rent and labor expense don’t come down along with that lower pricing – making each unit sale significantly less profitable.
And it’s not likely a problem that is going to change. The popularity of cheaper “bralettes” is a key factor. And with American Eagle Outfitters (NYSE:AEO) unit Aerie posting torrid 26% same-store sales growth in the first half of its fiscal 2017, on the strength of its own bralettes, Victoria’s Secret is going to have to compete on price going forward.
But what the coverage of the Cowen downgrade has missed is that it’s not just a bra problem. As Jefferies pointed out after Q2 results last month, panty sales declined year-over-year for the first time since the recession. With tops and bottoms both facing challenges, it’s tough to get too excited about a turnaround for Victoria’s Secret — and LB stock — any time soon.
It Can Get Worse for Victoria’s Secret
The problem for LB stock is that it’s not entirely clear how the Victoria’s Secret unit can fix its pricing and sales problems. The pricing pressure, at least per LB management commentary, isn’t coming from fashion misses or poor marketing. Rather, the problem is external. Women are focusing on comfort — and price. They’re choosing bralettes and sports bras instead of the more expensive bras for which Victoria’s Secret is known.
Those preferences, in turn push, customers to Aerie and Lululemon Athletica Inc. (NASDAQ:LULU), who have established franchises in those categories.
More broadly, it’s hard to argue that Victoria’s Secret is positioned all that well for the current political and social moment. Airbrushed images of rail-thin “Angels” selling $60 bras seems a dangerous effort in an age where “body-shaming” is criticized and self-image is paramount.
Unilever NV (ADR) (NYSE:UN, NYSE:UL) brand Dove has been running a successful “Real Beauty” campaign for years that has reinvigorated the brand. That campaign seems the exact opposite of what Victoria’s Secret sells.
If that’s the case, there’s really not much Victoria’s Secret can do — except, possibly, capitulate on pricing. But that’s precisely the outcome Cowen fears — and with good reason.
LB Stock Isn’t Cheap Enough
LB’s long decline has made the stock look relatively inexpensive. Wednesday’s price above $37 suggests just a 12x multiple to the midpoint of full-year EPS guidance. And while Victoria’s Secret grabs the headline, the Bath & Body Works unit actually continues to perform well. Comparable store sales for that unit rose 6% in 2016 and 7% in 2015, before a 4% increase this year.
So there is a case here that if Victoria’s Secret stabilizes, and Bath & Body Works — which drives roughly 40% of operating profit — continues to grow, the sell-off in L Brands stock is overdone.
Truthfully, I’m skeptical on that point. Victoria’s Secret isn’t stabilized — not close. Comparable store sales for the brand are down 14% year-to-date, with a bit over half of that driven by the decision to exit the swim business. The business generally needs positive comps of 3% or more just to leverage expenses, and pricing will only add to the margin pressure.
As for Bath & Body Works, declining mall traffic will be a continuing headwind; even the best mall retailers have seen growth end, eventually. The combination of a slowdown in B&BW plus the problems at Victoria’s Secret will be too much for L Brands stock to handle. And even if Bath & Body Works grows, what looks like a potentially multiyear decline at Victoria’s Secret will offset that growth. A 12x multiple, in that context, isn’t close to cheap enough.
As of this writing, Vince Martin has no positions in any securities mentioned.