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L Brands (LB) Down More Than 6% Despite Q4 Earnings Beat

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L Brands, Inc. (LB - Free Report) reported fourth-quarter fiscal 2018 results, wherein top and bottom lines improved year over year and the latter marked its fifth consecutive quarter of positive surprise. However, results remained dismal in the company’s Victoria’s Secret business, which has long been battling competition and consumers’ changing preferences.

In fiscal 2019, sales are likely to be hurt by La Senza’s sale and closure of Henri Bendel business. Moreover, soft merchandise margins are likely to hit gross margin rate. These factors led to a not so impressive guidance, which seems to have hurt investors’ confidence. Well, shares of the company lost 6.2% during the after-market trading on Feb 27. In the past three months, the company’s stock plunged closed to 19% compared with the S&P 500’s growth of 1.8%.

Markedly, management envisions fiscal 2019 earnings per share to be $2.20-$2.60, lower than the current consensus mark of $2.65. The guidance includes nearly 14 cents impact from greater tax rate. Moreover, earnings per share are envisioned to be breakeven in the first quarter compared with the Zacks Consensus Estimate of 12 cents.

Detailed Quarterly Discussion

In the quarter under review, L Brands’ adjusted earnings came in at $2.14 per share, which outpaced the Zacks Consensus Estimate of $2.07. Also, the bottom line improved 1.4% year over year. Solid performance by Bath & Body Works was the primary driving factor.

Net sales climbed marginally to $4.85 billion. The top-line figure came in line with the Zacks Consensus Estimate. Furthermore, L Brands’ total comparable sales climbed 3% in the quarter.  

Victoria’s Secret sales dropped 5% to $2,532 million. Comparable sales fell 3%, while comparable store sales (comps) tumbled 7%. Comps remained flat in the lingerie business, whereas the same declined low-double digits at PINK. On the brighter side, Victoria’s Secret Beauty comps saw a mid-single-digit jump. Also, total digital sales registered an increase of 8%.

Management stated that Victoria’s Secret results in this segment lagged expectations as comps declined and merchandise margins fell considerably in all core categories. The fall in margins stemmed from elevated promotions to boost traffic and clear inventories.

On the contrary, Bath & Body Works’ (BBW) delivered a solid show and surpassed management’s expectations. Total sales here improved 9% to $1,951 million, with 12% rise in comparable sales and 8% growth in comparable store sales.

Sales were fuelled by robust improvements in the three key categories, including home fragrance, soap and body care. Notably, product acceptance for the Fall and Holiday season items aided results.
BBW direct channel remained sturdy, with sales up 30%. Also, merchandise margin rose on the back of lower promotions.

We also note that L Brands’ International sales rallied 12% in the fourth quarter to $190.7 million, courtesy of strength across both Victoria’s Secret and BBW.

L Brands’ adjusted gross profit dropped 3.6% to roughly $1,967.7 million, while the adjusted gross margin contracted 170 basis points (bps) to 40.6%. Reduction in merchandise margin rate and higher occupancy costs led to gross margin decline.

Adjusted operating income declined from $986.6 million to $898.7 million, as strength in Bath and Body Works was more than offset by softness in Victoria’s Secret. Adjusted operating margin collapsed 200 bps to 18.5%.

Store Update

In fiscal 2018, L Brands opened three Victoria’s Secret stores and shuttered 30, taking the total count to 1,143. In the same period, 55 Bath & Body Works stores were inaugurated and 28 were closed, which totaled to 1,721 stores.

At the end of fiscal 2018, this specialty retailer of women’s intimate and other apparel had 79 international stores. The company sold its La Senza stores (United States and Canada) to an affiliate on Regent LP this January. As of Feb 2, 2019, L Brands operated 2,943 stores.

Total franchised stores (as of Feb 2, 2019) were 674, including 219 Victoria’s Secret Beauty & Accessories, 47 Victoria’s Secret, nine Pink and 223 Bath & Body Works stores. The company sold its La Senza stores. Also, the franchised stores comprised 164 and 12 Travel Retail stores of Victoria’s Secret Beauty & Accessories and Bath & Body Works, respectively.

Other Financial Details

L Brands exited the quarter with cash and cash equivalents of $1,413.5 million, down from the prior-year quarter’s $1,514.9 million. Long-term debt increased marginally to $5,739.4 million from nearly $5,707 million a year ago. Shareholders’ deficit came in at $865.6 million.

For fiscal 2019, the company projects capital expenditures to be $575-$600 million. It anticipates free cash flow of $700 million for the same period.

In fiscal 2018, L Brands repurchased 5.4 million shares for $196.1 million. As of Feb 2, 2019, the company had shares worth $78.7 million remaining under its existing $250 million buyback plan.

Guidance

Toward the end of fiscal 2018, management decided to shut its Henri Bendel business, sell off La Senza and reset its dividend. These actions are likely to help the company focus on the core areas with higher growth potential. In fiscal 2019, management intends to remain committed toward improving Victoria’s Secret’s performance by staying customer-focused, enriching assortments, and enhancing store and online experiences.

Further, the Zacks Rank #3 (Hold) company focuses on efficient management of costs, capital and inventory. Additionally, the company announced that it will stop reporting monthly sales and only report quarterly sales data, henceforth.

All said, L Brands anticipates first-quarter fiscal 2019 comps to fall low-single digits. Total sales growth is expected to be roughly 1 point lower than comps. This can be accountable to La Senza’s and Henri Bendel’s loss. Further, gross margin is expected to contract year over year due to lower merchandise margins.

SG&A costs are anticipated to escalate as a percentage of sales on account of lower sales. Earnings per share are envisioned to be breakeven in the first quarter compared with 17 cents recorded in the year-ago period. This includes nearly 5 cents adverse impact from higher tax rate. Also, the earnings guidance for the first quarter falls way below the Zacks Consensus Estimate of 12 cents.

For fiscal 2019, the company anticipates comps to rise low-single digits. Total sales growth is likely to lag comps by about 2 points due to the same factors impacting the first-quarter sales. Gross margin rate is likely to decrease year over year, mainly due to lower merchandise margins. SG&A costs are expected to increase year over year, stemming from higher wage rate and inflation-related pressure.

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