Introduction

Anyone how follows the United States economy knows that traditional brick and mortar retail has been dying a slow death. L Brands (LB) is seemingly becoming another casualty of this trend. Once a business with many strong, growing brands, L Brands has been whittled down to just Victoria’s Secret and Bath & Body Works. Although Victoria’s Secret may be the most widely known brand of the two, it has seen consistently declining sales, while Bath & Body Works has seen the opposite.

With the Sycamore Partners deal collapsing, which was going to off-load 55% of Victoria’s Secret, L Brands is back being a laggard. Although I wouldn’t invest in L Brands as a long-term investment as the traditional retail industry is declining and the current valuation is high, there may be an opportunity for arbitrage in the future if L Brands goes bankrupt or acquired.

Victoria’s Secret Struggles

Revenue, Comparable Store Sales, And Operating Income

L Brands RevenueL Brands Operating IncomeSource: SEC 10-Ks

Once the golden goose of the company, Victoria’s Secret has become the dog of L Brands. Victoria’s Secret revenues have decreased at a rate of 2.37% per year since 2015. For the segment, the sale per square foot has declined even faster, with an average yearly decline of 4.56%. This has resulted in poor business segment economics, with this segment’s operating margins decreasing every year to -9.1% in 2019.

L Brands Comparable Store SalesL Brands Sales per Square FootSource: SEC 10-Ks

All of the poor financial results are attributable to declining comparable store sales every year. Even considering direct-to-consumer sales, Victoria’s Secret still has performed poorly. This is in stark contrast to Bath & Body Works, which has seen the exact opposite trends. Bath & Body Works has seen revenue growth of 7.59% per year over the last five years and operating margins of 23%. To top it off, Bath & Body Works comparable store sales have been at least high-single digits every year.

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In 2020, the COVID-19 pandemic has made its mark on L Brands. Over the past six months, L Brands has seen revenue decline to $3.974 billion, or 28%. But some people were happy with the past two quarters’ results. Comparable store sales for both segments were reported at +84% and +6% for Bath & Body Works and Victoria’s Secret, respectively. On the surface, this looks great. A retail company that has been able to perform during the pandemic and their laggard brand even saw comparable store sale growth. But the reason these metrics are so positive is because of the number of store closures. L Brands only counts stores that were not closed for more than four consecutive days in these numbers. As you can expect, many have been closed due to the pandemic. In the end, L Brands saw Bath & Body Works revenue grow 13%, while Victoria’s Secret declined 39%. The result was a $346 million net loss.

Busted Sycamore Partners Deal

In February of 2020, L Brands and Sycamore Partners agreed to a deal to sell 55% of Victoria’s Secret for $525 million. L Brands was going to keep 45% of the “Victoria’s Secret Holdco” that was to be created. When this deal was announced, it showed promise in helping L Brands return to profitability. Not only would L Brands off-load 55% of a non-perfuming brand that has been dragging down the financials, but also Sycamore Partners has lots of experience within the retail industry giving hope to the idea that the brand could be revived. But as COVID-19 infections increased and the nation closed down, the deal was terminated. Overall, this was a huge disappointment to investors as this deal was supposed to help bring L Brands back to the realm of profitability and also help pay down debt.

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Financial Distressed

L Brands is a highly leveraged company with poor profitability. This is usually a recipe for problems, especially when people don’t want to be in large crowded areas such as shopping centers. L Brands does have good liquidity and, as of the most recent quarter, had a current ratio and quick ratio of 1.31x and 0.88x. This will allow L Brands to survive in the near term, especially with the 15% workforce reduction, but the company is all debt, with 6.269 billion on the books. Uncertainty about the length of the pandemic and consumer behavior afterward are headwinds for L Brands’ financial health. The company is taking measures to become more stable, but it will be hard to do without selling Victoria’s Secret. Overall, Sycamore Partners may have backed out of the deal because the economic environment changed, but maybe the group sees a possible opportunity to buy L Brands upon bankruptcy as they did with Ann Taylor, J. C. Penney, and Loft.

Valuation

In the current state, L Brands’ valuation is very high. But the company will more than likely spin-off or sell Victoria’s Secret, meaning Bath & Body Works will be the main component of L Brands. If something of that nature happens, I believe L Brands can easily post consistent earnings around $1.36 per share. At this EPS, the company would be sitting at a P/E of 25.74x. Honestly, with the lagging business segment divested, I still wouldn’t buy a retail company at a P/E of 25.74x.

Another thing to look at for value is the offer prices of recently bankrupt retail companies. Originally, when the Victoria’s Secret Holdco deal ended, I thought that Sycamore may be waiting for L Brands to go bankrupt to try and buy the whole company. Sycamore Partners put in bids for J. C. Penney, Loft, and Ann Taylor when the companies went bankrupt. During J. C. Penney’s bankruptcy, Sycamore Partners offered $1.75 Billion for just 300 stores. I believe L Brands is worth at least 4x or $6 billion. This would be about $21.74 a share if an acquisition were to happen upon any bankruptcy. Overall, even without the Victoria’s Secret brand, L Brands is in a tough industry, has a poor balance sheet, and is overvalued at 25.74x earnings.

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Conclusion

L Brands has taken a lot of losses this year. Victoria’s Secret is still a company laggard, and the deal to off-load 55% of the brand to Sycamore Partners fell through. To top it off, the COVID-19 pandemic has reduced foot traffic and therefore company-wide revenues. L Brands is surviving for now with enough liquidity, but debt needs to be reduced and a return to profitability is paramount. Many speculate that L Brands will either spin-off or sell the Victoria’s Secret brand to achieve this.

This is a great idea, but depending on the length of the pandemic and resulting consumer behavior L Brands may have serious financial issues ahead. Overall, I would not invest in this company at the current price of $35. This is a P/E around 25x if the company sold Victoria’s Secret. The only way I would invest in L Brands is on looming bankruptcy threat as I believe the company would be purchased close to the $15-20 per share range.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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