|Shares Out. (in M):||279||P/E||10.4||0|
|Market Cap (in $M):||7,827||P/FCF||9.8||0|
|Net Debt (in $M):||4,742||EBIT||1,384||0|
Quick Pitch / Variant View
I believe a long of L Brands, Inc. (“LB” or the “Company”) offers a compelling and asymmetric risk / reward profile for the patient investor as a result of (i) hidden asset value / earnings obfuscation from growth investments the Company is making internationally, (ii) sum of the parts (“SOTP”) margin of safety, (iii) alignment with a management team with a long track record of being competent stewards of capital, and (iv) significant upside potential should the Victoria’s Secret (“VS”) brand recover in North America (“VS NA”).
fogle42’s recent post provides background on the situation, the brands within the LB portfolio and why the opportunity exists, but I wanted to posit a variant view to the situation that I thought merited a new post (especially with the stock down an additional ~25%).
Specifically, I believe that at today’s price, an owner of LB is paying almost nothing to own VS NA and PINK while clipping a ~12% FCF yield (excluding growth investments the Company is making in China), not to mention a safe ~8.5% dividend yield. While much of the Street’s focus and short thesis has concentrated on the well-publicized struggles of VS NA (and more recently PINK), I believe Mr. Market is creating these assets at ~30% of FY ‘18 Revenue and 2.6x FY ‘18E EBITDA.
As a whole, LB currently trades at an undemanding <11x FY ‘18E EPS (<9x excluding International losses) on VS NA EBIT margins that are ~970bps lower than their ‘15 peak. Sentiment (and multiples) in retail can change very quickly. One needs to look no further than URBN, which is up ~160% from its August ‘17 lows as it has seen ~5 turns of ‘18E P/E multiple expansion as comps and margins have snapped back. While Core VS NA has unquestionably struggled to adjust to recent changes in consumer tastes, these are still strong brands that have the potential for recovery. While I do not have any special insight as to when that may happen, I believe LB represents a downside protected option on VS NA figuring how to serve today’s woman (as it has successfully done for the past ~30 years). Were it to do so, I don’t think it’s inconceivable for LB to trade at a high teens EPS multiple on expanded margins that would result in a double (or better) from current levels on top of the fat dividend yield.
Hidden Asset Value / Earnings Obfuscation
Between FY ‘15 and FY ‘18E, International EBIT declined from $88mm to effectively nil despite ~35% international franchise store growth (ex La Senza which falls under “Other” revenue). What happened? The Company has made significant investments in China (and to a lesser extent, the UK) with international owned store count growth of ~5x over the same period.
Thus while, the extremely high margin (~66% EBIT) franchise revenue has not gone away (and in fact, has increased), it has been obfuscated by investments in growing the China and UK retail businesses that could be turned off if the Company wanted to. Thus, when thinking about the true earnings potential of LB, I think one must recognize the ~$160mm investment being made in those operations. For those less familiar with the structure of LB’s international operations, I encourage you to listen to Martin Water’s 9/7/17 presentation at the GS conference, where he lays out the margin profile for each line of business in some detail.
Additionally, while China and the UK currently lose money, they offer significant upside potential (though mgmt’s persistent inability to right the ship in the UK is concerning), it seems silly to me to capitalize these losses in perpetuity. Consequently, I estimate the value of the International and Other segments using a SOTP methodology:
Franchise operations account for the vast majority of value here and I feel like 10x EBITDA is reasonable, if not conservative, based on where other franchisors trade. I value retail at 1x revenue, though think it could potentially be worth a lot more if the investments in China come to fruition. External MAST operations are definitely saleable as evidenced by the Company’s prior transaction with Sycamore, but have less visibility into them.
Bringing it all together, I think these two segments, which account for over ~$200mm of losses, are worth ~$1.6bn.
SOTP Margin of Safety
Bath & Body Works (“BBW”) is a somewhat divisive asset but its growth and margin profile speaks for itself as it continues to generate extremely high ROICs. Between FY ‘11 and FY ‘17, EBIT increased by $439mm vs ~$700mm of capex (not inclusive of FY ‘17 capex) for a pre-tax ROIC of ~62%. While it lacks a “perfect comp” URBN, PRTY and MIK trade at ~9x, ~8x and ~7x ‘18E EBITDA, respectively. Personally, I think BBW is superior to all of these businesses but for conservatism, I value BBW in the middle of the range at 8x.