Wednesday, July 1, 2015

A Closer Look at a Watch List Stock: L Brands (NYSE: LB)

Some time ago I heard a saying that made absolutely perfect sense- when you enter in to a business you can be an employee, a consumer, or a part owner. When that business sells goods at considerably high price points (at least for the average consumer) and loyal customers still make the purchases without blinking, being a part owner becomes an extremely attractive proposition. 
L Brands has been on my watch list for about a year. I decided to dig deeper in to this company for more information and here is what I found. 
The Business
The name of this company may not look familiar at first glance but is actually the parent company of wildly popular retailers including Victoria Secret, PINK, Bath & Body Works, Henri Bendel, and La Senza (Canada-based Lingerie Company).

As specified in their annual report, the company's competitive advantage comes from:
-Strong brand recognition
-A very loyal customer base
-Frequent and innovative launches of products and apparel (including perfume, lingerie, sportswear, and other fashion items sold specifically at the Victoria Secret and PINK divisions).
As of January 2015; L Brands had a total of 2,685 stores including licensing agreements and franchises within the U.S and around the world.

Something that is very notable about this company is its management. CEO Leslie H. Wexner has actually been Chief Executive Officer of Victoria Secret since he founded the company in 1963 and has been chairman of the Board of Directors since 1975. Mr. Wexner is now 77 years of age. Next in tenure is also Chief Executive Officer and president, Sharen Turney, 58, who has held her position since July of 2006. This talks to the level of commitment at the helm and management that stays the course, tied to the success of the company and its continuous growth and success over time.
The most profitable segment in this company is Victoria Secret followed by Bath & Body Works.

Fiscal Year 2014
For full year 2014, the company achieved the following:
  • 1. Net sales of $11.454 Billion (an increase of $681 million in comparison to 2013)

  • 2. Comparative store sales across all stores in North America increased 4% year over year

  • 3. Operating Income increased from 16.2% in fiscal 2013 to 17.1% in 2014, this was as a result of growth across all segments

  • 4. Earnings per share increased by 15% to $3.50

  • 5. Capital expenditures of $715 million which included $553 million for opening new stores, remodeling, improving existing stores.
Specifically for the Victoria Secret division- Net sales increased $323 million to $7.207 billion. Comparable store sales increased 3%. Significant boost in net sales results include net sales increase of 6% within PINK stores as well as strong performance in core lingerie and sportswear driven apparel. Results were offset partially by a decrease in sales of beauty products due to exit of the makeup category.

Strategic Moves: Discontinuing make up line
In March of 2014; the company announced plans to discontinue the make-up line along with some low-selling categories within apparel. 
The goal of eliminating such divisions is to allow L Brands to zero-in to boosting sales of their more profitable businesses and products including swim and sports apparel, loungewear, and fragrances. As per CEO, Ms. Turney, those businesses together with the core lingerie business and Pink Brand are the fastest growing and most profitable categories within the company.
Despite the elimination of said categories, the Victoria Secret division still ended fiscal 2014 with net sales increase of 6% due to the performance of PINK, core lingerie, and sportswear- driven by a compelling assortment of merchandise that incorporated new and fashionable product offerings which succeeded in attracting consumers and hence, increasing same store sales. In store execution and improved operations also contributed to the results.
Valuation and Financials
L brands currently trades at 22.8x forward earnings with a 5 yr MA of 18.5x. Current P/E stands at 22.87. Compared to its closest competitors, L Brands may seem a bit on the pricier side. Below are valuation numbers for Gap Inc. (NYSE: GPS) and Hanes Brands Inc (NYSE: HBI)
Direct Competitor Comparison
Market Cap:
Operating Margin :
Net Income :
*Information adapted from data on Yahoo! Finance and Morningstar.
Important to keep in mind that companies like Victoria Secret's have a type of branding that is incredibly strong. Theoretically, in some consumer's mind- especially those of very loyal customers, there may not be an exact replacement or substitution. For Bath and Body works its closest competitor is The Body Shop, however, that company is not publicly traded.
As of January 31st 2015; L brands had about 1.6 billion of cash on hand and 4.7 billion of long term debt, majority of which are promissory notes at fixed interest rates, as per the annual report for fiscal 2014. Although debt may appear high, looking back year over year, debt has remained fairly consistent with no significant spikes, which is something to note. The company also specifies their capital expenditures are increasing as part of their strategies for expansion and growth (explained below).
Company has an annual dividend yield of 2.30% ($2.00 per share).

Strategies for Growth
Many probably ask themselves- can a company like L Brands with its multiple divisions maintain their strong branding position for many years to come? This is a valid question that all prospective and existing long term investors should in fact explore.
To answer some of investors questions in regards to long term profitability, L brands outlines clear and concise strategies for sustaining their popularity and continuous growth going forward. Plans of action include:
1. Growing the business in North America- Specifically for Victoria Secret, the plan for full fiscal 2015 is to increase square footage of stores in N.A by about of about 5% through expansions of existing stores and the opening of approximately 26 net new Victoria Secret stores (21 in U.S, 5 in Canada). For Bath & Body Works; the plan is to increase square footage of stores in N.A. by about 3% and the opening of 24 net new Bath & Body Works stores (14 in the U.S and 10 in Canada). Company is also making investments to improve e-commerce venues- which all stores have. The online channel for, specifically, continues to exhibit significant growth year over year.
2. Extending Core Brand Internationally- L Brands see a lot of opportunity at the international level and has actually assigned dedicated teams for the task which have taken a methodical "test and learn" approach to expansion outside of the U.S. International expansion began with the acquisition of La Senza back in 2007. L brands also continues to expand their partnering agreements with small-format stores around the world as well as at airports and other various locations. This allows for the exposure of the Victoria Secret name, and branding of most profitable segments, to continue strengthening worldwide.
3. Focus on the business fundamentals including efficient and disciplined management of inventory, expenses, and capital- The Company has dedicated strategic efforts to improving efficiency within operations all across the board and for all brands within its umbrella. Focusing on the fundamentals includes a special attention to the customer and their preferences, paying close attention to core merchandise categories, inventory management, speed and agility, and store selling and execution.

Final Thoughts {Would invest in this company?}
After taking a closer look at this company as an investor rather than a consumer, I do see some promising long term benefits of owning the stock.

I was just thinking about this-- a $350 shopping spree at this store (which is what a lot of people easily spend there) can buy approximately 3-4 shares at today's prices (currently trades at ~$85.87 per share). It may not sound like much but taking in to consideration stock price appreciation plus dividend reinvestment over time, this can be a nice addition to a portfolio.

I really like their strategic plans of action which includes expanding and strengthening the most popular brands at an international level. I also liked that the company identified less-profitable divisions and decided to eliminate them in order to focus in the parts of the company that make it profitable.
Going forward I'll be keeping an eye on continuous growth in same store sales and whether the increase in square footage and number of stores across the U.S is in fact profitable over time. I would zero in on sales, profits, and gross margins year over year. 
Another thing I am curious about is L Brands succession plans- CEO Wexner, which has been there from the beginning, is in his late 70s.

I am not ready to buy shares as of yet and would likely wait for a market pull back of sorts before I make the plunge. The price is about 10% under its 52-week high and, although the dividend yield is at a nice 2.30%, I am a little weary of the 97% dividend payout ratio and would like to look a bit more in to this.

It was very interesting to examine this company as an investor rather than a consumer and look forward to keeping an eye on developments.

If the company makes the plunge from my watch list in to my actual investment portfolio, I will be sure to you all informed.

What are your thoughts?

Thanks for reading and cheers to profits!

*I have no shares in any of the companies mentioned in this report.