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L Brands (LB) Up 2.5% Since Last Earnings Report: Can It Continue?

A month has gone by since the last earnings report for L Brands (LB). Shares have added about 2.5% in that time frame, outperforming the S&P 500.

Will the recent positive trend continue leading up to its next earnings release, or is L Brands due for a pullback? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at the most recent earnings report in order to get a better handle on the important drivers.

L Brands Q2 Earnings Surpass Estimates

L Brands, Inc. reported stronger-than-anticipated second-quarter fiscal 2020 results. Sturdy performance at Bath & Body Works coupled with strength in the direct business at Victoria’s Secret segment drove the results. However, store closures at some point during the quarter under review owing to the pandemic did hurt the company’s business. Consequently, the top line declined from the year-ago period. Nonetheless, the bottom line improved year over year.

Without a doubt, L Brands remains focused on cost containment, inventory management and curbing capital expenditures. Markedly, the company in co-operation with suppliers has been identifying opportunities to lower merchandise costs in order to increase merchandise margin rates at Victoria’s Secret. Also, management remains committed toward making Bath & Body Works chain a “pure-play public company” and Victoria’s Secret, “a separate, standalone company.”

Notably, management concluded the comprehensive review of its home office organizations in order to lower overhead expenses, and decentralize significant shared corporate and other functions to create standalone companies. This resulted in a reduction of about 15% of its corporate staff or roughly 850 employees. We note that L Brands plans to lower annual costs by approximately $400 million. Of the targeted cost reduction plan, the company anticipates to accomplish roughly $175 million in the remainder of fiscal 2020.

Detailed Quarterly Discussion

L Brands reported adjusted earnings of 25 cents a share against the Zacks Consensus Estimate of a loss of 34 cents. Notably, the bottom line improved by a penny from the year-ago period owing to lower general, administrative and store operating expenses.

Net sales of $2,319.5 million came ahead of the Zacks Consensus Estimate of $2,271 million, following a miss in the preceding four quarters. However, the top line fell 20% on a year-over-year basis. The decline can be attributed to the closure of stores during periods of time throughout the quarter due to COVID-19. While Bath & Body Works stores were closed for about half of the quarter, Victoria’s Secret stores were closed for roughly 70% of the period.

Comparable sales (stores and direct business) rose 63% during the quarter against 1% decline in the year-ago period. Again, comparable sales (stores only) jumped 33% against 4% fall in the prior-year quarter.

Total sales for Victoria’s Secret declined 39% to $977.5 million. Comparable sales (stores and direct business) increased 28%, while comparable store sales declined 10%. Notably, sales in the direct business surged 65% to $613.9 million, reflecting remarkable growth in the Lingerie, PINK and Beauty businesses. Moreover, the Victoria’s Secret merchandise margin rate rose meaningfully in the quarter owing to pullback in promotional activity and better pricing during semi-annual sale. However, we note that store sales fell 70% to $363.6 million during the quarter. Additionally, adjusted operating loss for the segment was $38.9 million against adjusted operating income of $16.6 million in the year-ago period.

Bath & Body Works’ total sales increased 13% to $1,196.7 million. While comparable sales (stores and direct business) soared 123%, comparable store sales increased 87%. We note that “pent-up demand” for products following store closures in March and April, higher demand for soaps and sanitizers, government stimulus checks that supported consumer spending and increased traffic in locations opened during the quarter drove comparable store sales performance. Although store sales fell 23% to $678.1 million during the quarter, direct channel sales improved by 191% to $518.6 million. The company also witnessed strong comp performance in Body Care and Home Fragrance. Additionally, the Bath & Body Works merchandise margin rate rose significantly during the quarter owing to stronger product margin rate. Adjusted operating income for the segment came in at $330.9 million, up sharply from $180.2 million reported in the year-ago period.

We note that L Brands’ International sales were $80 million in the reported quarter, down 48% year over year. The sharp fall can primarily be attributed to the significant number of temporary store closures. Nonetheless, revenues improved slightly for Bath & Body Works international despite closure of the international franchised stores throughout the quarter. Strong in-store sales after reopening and robust online demand aided revenue growth.

Although L Brands’ adjusted gross profit declined 20% year over year to $790.4 million during the quarter, we note that gross margin expanded 20 bps to 34.1%. This expansion was driven by a significant improvement in the merchandise margin rate, partly offset by buying and occupancy expense deleverage. Adjusted operating income grew 18% to $205.7 million, while operating margin increased 290 bps to 8.9%.

Adjusted SG&A expenses fell 28% to $584.7 million during the quarter. As a percentage of net sales, SG&A expenses contracted 260 bps to 25.2% owing to lower store selling costs.

Store Update

As of Aug 1, 2020, company-owned stores were 2,709, including 884 Victoria’s Secret stores, 1,735 Bath & Body Works, 21 Victoria’s Secret U.K./Ireland, five PINK U.K., 39 Victoria’s Secret Beauty and Accessories and 25 Victoria’s Secret China. Total non-company-owned stores were 721, including 200 Victoria’s Secret Beauty & Accessories, 75 Victoria’s Secret, 13 Pink and 267 Bath & Body Works stores. Further, non company-owned stores comprised 149 and 17 Travel Retail stores of Victoria’s Secret Beauty & Accessories and Bath & Body Works, respectively.

With respect to Bath & Body Works segment, L Brands expects roughly 55 real estate projects (new stores and remodels) for fiscal 2020. The company plans to open about 27 new stores and is also evaluating all locations. So far in the year, the company has permanently closed 14 outlets, and anticipates approximately 30-50 closures for the fiscal year. Year to date, the company has shuttered 210 Victoria’s Secret stores in the United States and Canada. Notably, it remains on track to close approximately 250 stores in the current fiscal year.

Other Financial Details

L Brands ended second quarter with cash and cash equivalents of $2,611.4 million, up from $852.5 million at the end of the prior-year quarter. Long-term debt increased to $6,268.6 million from $5,475.4 million a year ago. Shareholders’ deficit was $1,903.5 million. Management incurred capital expenditures of $68.8 million in the quarter under review. The company generated free cash flow of approximately $560 million during the quarter under review.

The company converted revolving credit facility to an asset-backed loan facility and issued $1.25 billion in new notes. The company intends to use a portion of the proceeds to retire the $450 million maturity due in April 2021. The company has not drawn any amount under the asset-backed loan facility.

Outlook

In the second half of the fiscal year, L Brands will remain focused on disciplined expense and inventory management, and providing compelling products. Additionally, management expects direct business to remain strong. However, it holds a cautious outlook for the holiday season, thanks to traffic constraints in stores due to social distancing measures and capacity restraints in direct channel distribution centers. The company informed that historically typical holiday volumes are about three times larger per week than the average week in the second quarter. Nonetheless, management is working on plans to spread holiday volume out over a broader time period and to pull some volume out of the fourth quarter and into the third.

Further, L Brands envisions significant expense pressure owing to higher store expenses, including payroll and supplies, as a result of the new labor model on account of social distancing measures, wage rate inflation in the domestic supply chain, and increased direct channel fulfillment and shipping costs.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed an upward trend in estimates revision. The consensus estimate has shifted 129.14% due to these changes.

VGM Scores

At this time, L Brands has a great Growth Score of A, a grade with the same score on the momentum front. Following the exact same course, the stock was allocated a grade of A on the value side, putting it in the top 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of A. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending upward for the stock, and the magnitude of these revisions looks promising. Notably, L Brands has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.


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