L Brands (LB)

Courtesy of Tijuana Jackson Academy

TICKER:  LB

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L brands saw disruptions in 2020, when its retail stores had to be closed for significant periods of time. With disruption in sales and mounting debt, the company struggled during most parts of the year. But the pandemic may have been a blessing in disguise for the company, as it has worked on a quick turnaround. This includes suspending dividends and buybacks, reduction in capital expenditure and spinning off Victoria’s secret, which has continued to struggle. 

Cost Reduction Efforts

Victoria’s Secret’s, the flagship brand of the company has struggled with both revenue and profitability declining significantly over the last few years. Revenues have fallen from $8.1 billion in 2018 to $5.4 billion in 2020, while operating income has slid over 70% in the same period. In 2020, management undertook a number of steps for cost reduction, with the program set to save the company over $400 million in profits. 

This includes closure of over 240 unprofitable stores in North America, restructuring the company’s UK business and Renegotiating Leases in Shanghai and Beijing. VS also incurred significant layoffs with over 15% of  its home office employees being let go. In addition, the company is also planning a spinoff with Victoria Secrets and Bed & Body works becoming two separate entities, through a tax free spin off. 

Bed & Body Works Offers a Strong Value Proposition 

After the spinoff, Bed & body Works will be a separate pure play entity, which is great news for investors considering it offers a great value proposition. BBW has continued to grow steadily with revenues up 37% since 2018 and Operating Income up over 63%. With the brand spanning across 1736 stores worldwide, it is the retailer in Fragrance, Body Moisturiser and Hand Sanitiser in most markets. 

BBW also continues to significantly improve sales through a combination of retail expansion and significant online expansion. For instance, the average sales per square foot was up from $815 in 2015 to $916 in 2020. The company’s ominichannel presence was also more prevalent in 2020, when Digital sales made up 32% of the total sales of the company. 

Valuation

While the company’s revenues have declined slightly, primarily due to poor sales from VS, it continues to improve its free cash flow position, which is crucial considering the company’s massive debt position. Free Cash Flows have improved from $1 Billion in 2017 to $1.8 Billion, as the company has chosen to move away from dividends and buybacks, in favour of paying off debt. 

The company’s current debt including existing lease liabilities stands at $9.45 billion, resulting in a Debt/EBITDA ratio of 3.94x, which is significantly higher than the company’s position three years ago when the Debt/EBITDA was 3x. Fortunately, with the company’s renewed focus on debt reduction, the balance sheet should significantly improve over the next few years. 

In terms of valuation, the company is significantly discounted for, when compared to its peers. The company is trading at a P/E of 12.58, which is significantly less than the sector median of 18.44. As the company continues its cost reduction measures, improves the margin-mix through growing digital sales and pays of debt, the company’s earnings should continue to improve, resulting in higher valuations in the future. 

Conclusion 

L Brands is currently in the middle of a significant turnaround. After several years of declining sales and weak profitability, management has adopted various cost cutting strategies and is spinning off its flagship brands. With millions of consumers around the world coming out of the pandemic, the company should see a significant boost in sales. This coupled with an improving margin mix through increased digital sales and continued debt reduction, should materially improve valuation moving forward.