Why Investors Should Wait to Buy L Brands Stock on This Dip

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LB stock - Why Investors Should Wait to Buy L Brands Stock on This Dip

Source: Eternity Portfolio via Flickr (modified)

Retail is back! However, L Brands (NYSE:LB), the parent company of Victoria’s Secret and Bath & Body Works, didn’t get that memo. L Brands recently reported second-quarter numbers that were largely above expectations, but the full-year guide was trimmed by ~10% and the underlying numbers pointed to continued weakness at Victoria’s Secret.

LB stock dropped big in response to the news. It now trades at its lowest levels since mid-2011. To put that in perspective, the S&P 500 is up more than 150% during that stretch.

Clearly, LB stock has been a long-term loser.

Unfortunately, I’m not so sure this losing streak turns around yet. There is no denying the fact that LB stock is dirt cheap, and that this is a wide-moat company with healthy long-term growth prospects. Indeed, in a four-to-five year window, I see LB stock nearly doubling to above $55.

But, the big rebound in LB stock won’t happen until margins stabilize. Right now, no one really knows when that will happen. Margins have been in free fall for several quarters, remain in free fall today and are expected to remain in free fall into the end of the year. Until those falling margins turnaround, LB stock will have a tough time fighting for gains.

L Brands Quarter Affirms Secular Challenges for Victoria’s Secret

To be clear, there are two parts to the L Brands narrative. The first part is Bath & Body Works, or BBW for short. That part of the narrative is doing fairly well, with consistently strong comparable sales growth and stable margins.

The other part is Victoria’s Secret, or VS for short. That part of the narrative is awful. There is no other way to put it. Comparable sales growth is still negative, even after lapping huge declines last year, and margins are tumbling.

What is going on at VS? Secular changes in the intimates marketplace are creating demand headwinds for the bombshell beauty products that VS made a killing on over the past several years. Specifically, there has been a huge shift in the intimates marketplace from bombshell beauty (push-up bras and other provocative intimates) to natural beauty (free-flowing bralettes and other natural looking intimates).

That is why bombshell intimates retailer VS has struggled over the past several quarters, while natural intimates retailer Aerie has been on fire (38% comparable sales growth last quarter). To see a chart of how this trend has impacted each retailer’s respective popularity over the past several years, take a look this Google search interest chart. Five years ago, VS was twice as searched on the internet as Aerie. Now, Aerie has more search volume than VS.

These trends aren’t slowing down. VS continues to struggle. Aerie continues to remain red-hot. In order to compete, VS is running deep discounts. That is stabilizing sales. But, it is coming at the expense of margins. Gross and operating margins at VS are down huge this year.

Overall, VS is significantly challenged right now, and L Brands second-quarter numbers affirm that competitive pressures aren’t easing all that much. Thus, going forward, investors should continue to expect weak numbers from VS.

L Brands Stock Won’t Jump Until Margins Stabilize

Long-term, bombshell beauty won’t die. It is simply down-sizing in popularity right now. Eventually, VS comparable sales will stabilize and return to consistent healthy growth. Margins will also stabilize, and the whole L Brands narrative will turnaround.

Because LB stock is so cheap right now (around 10X forward earnings), a positive narrative inflection could spark a huge rally in the stock. As such, I reasonably see LB stock heading toward $55 over the next four to five years (market-average 16X multiple on my long-term earnings-per-share estimate of $3.50).

That is almost double the current price tag. Needless to say, I’m bullish on LB stock in the long run.

But, I’m also aware that a big rebound in LB stock is predicated on the VS business stabilizing. Specifically, it is predicated on margins in the VS business stabilizing, as sales have arguably already stabilized, but at the expense of margins. The market doesn’t have any proof that this stabilization will happen any time soon. Thus, LB stock continues to trade weakly.

Once the market gets proof through a quarterly earnings report that VS margins are stabilizing and could head higher, LB stock will soar toward $55. Until then, this stock will likely remain weak.

Bottom Line on LB Stock

Near-term, LB stock is challenged by persistent demand and margin headwinds at VS. Long-term, those headwinds will ease, and LB stock will soar higher.

Thus, the investment takeaway is simple. If you can stomach near-term pain, take small bites here. Then, once you get proof in a subsequent earnings report that margins are stabilizing, take a bigger bite. Overall, expect near-term pain and long-term gain.

As of this writing, Luke Lango was long LB.


Article printed from InvestorPlace Media, https://investorplace.com/2018/08/why-investors-should-wait-to-buy-l-brands-stock-on-this-dip/.

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