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Limited Brands has lately become even more limited -- but in a good way.
The narrowing of its focus to two major retail brands should pay off for investors, even if the immediate outlook for sales growth is choppy amid signs of consumers' spending fatigue and a short-term bulge in inventories.
The two chains that now drive the company -- Victoria's Secret and Bath & Body Works -- dominate their categories. Both enjoy impressive profit margins and are in niches with attractive long-term prospects.
Shares of Limited Brands (LTD, news, msgs) also offer a play on a possible investor-friendly financial restructuring, an intriguing retail-services business and an implied call option on a handful of new store concepts.
But first, investors might have to wait out a transition year as Victoria's Secret faces comparisons with strong 2006 sales trends and spends heavily to enlarge its stores, raising the chance that an already-skeptical Wall Street could pan month-to-month results and grow hostile. A sharp pullback in the stock, attractively valued around $26 recently, probably would be a gift of a buying opportunity.
A 2% rise in same-store sales for May, reported June 7, beat forecasts of a small decline and seemed to quell some analysts' fears that a recent run of sluggish sales and shrinking margins at Victoria's Secret would snowball.
The leaner corporate profile results from Limited's agreement last month to sell two-thirds of its Express apparel business to private-equity firm Golden Gate Capital, a $431 million deal that would bring Limited pretax cash proceeds of $548 million after Express pays the parent a $117 million debt-financed dividend. Limited is paring its exposure to lower-margin and slower-growth clothing lines. The company is now exploring options for its barely profitable Limited stores.
Limited Brands is using the Express money to repurchase up to $500 million in stock, a significant percentage of its $10.6 billion market capitalization.
In largely exiting the apparel business, Limited has become a play on body consciousness and self-pampering, selling lingerie and lotions, bustiers and bath salts -- categories that are in a cultural sweet spot.
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Skepticism abounds
Yet there is significant skepticism on Wall Street that Limited can deliver. That's why its stock price sits 20% below its late-2006 high and trades at a modest 14 times expected 2008 earnings.Limited's enterprise value -- market cap plus net debt -- is less than eight times earnings before interest, taxes, depreciation and amortization (EBITDA, a measure of cash flow), barely that of struggling retailers such as The Gap (GPS, news, msgs). This, in a market where unremarkable retailers have been taken private at valuations near 10 times EBITDA.
Skeptics fixate on the erosion in Victoria's Secret's sales growth and profit margins. As Morgan Stanley analyst Michelle Clark wrote in downgrading Limited to the equivalent of a "hold" May 29, "The pace and degree of operating-margin deterioration" is "concerning."
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The Secret to Limited Brands' success?Persistent weakness at its apparel stores has Limited Brands increasingly reliant on lingerie sales for growth.
It's unclear whether competitors' initiatives in pushing lingerie and "lounge-wear" have weakened Victoria's Secret's hold on its customers. The Gap, J.C. Penney (JCP, news, msgs) and others are heavily targeting this area.
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