In October, I said I would avoid shares of L Brands until management had a better handle on the business. I was concerned about the shift to more comfortable, less expensive and more fashionable bralettes. Bralettes typically cost around $20, while traditional bras can cost upwards of $80. Bralettes are easily manufactured and come in just three sizes -- small, medium and large. A regular bra is difficult to manufacture and can have 20 or more sizes. As bralettes proliferate, Victoria's Secret could lose market share and sales.
Of the estimated $12 billion in sales for fiscal 2016, about 62% (or $7.7 billion) come from Victoria's Secret. The rest of the business, which is mostly Bath & Body Works, is doing just fine.
Last quarter, Bath & Body Works posted a 5% comparable-store sales figure. Including online sales, B&BW was up 7%. Bath & Body Works reported an operating margin of 18.9%, down just 45 basis points. Victoria's Secret said comparable-store sales fell 2% and online comps fell 1%.
Gross profits were destroyed by some serious clearance activity. VS said operating margins fell 311 basis points to 10.3%. Because of the dramatic decline at VS, the company's overall operating margin ended the quarter at 11%, down 266 basis points.
Even with a 4% increase in sales, the store deleverage was wicked. Selling, general and administrative expenses rose 7%. Earnings per share were down 24% as operating profit fell 16%. The company ended the quarter with 3,070 stores.
When you have 3,000 stores filled with stuff nobody wants to buy, it's a mess!
Fortunately, management recognized the problems and has taken corrective action. First, VS dumped apparel and swimwear and got back to its lingerie roots. Second, the company cut back on sales promotions and couponing. Third, it eliminated the catalog. And fourth, VS CEO Sharen Jester Turney resigned.
L Brands reports fourth-quarter fiscal 2016 sales on Feb. 22, and the consensus is looking for earnings per share of $1.97 on revenue of $4.56 billion.
To me, that's a stretch. For L Brands to get to the consensus revenue estimate, sales have to be up nearly 4%. Last year, fourth-quarter sales were up 8%, but last year the company was able to post double the sales growth and had an operating income of 18%. Gross margins will end the year down about 180 basis points. L Brands will be lucky to have an operating income of 16% this year.
For the company to hit analysts' estimates, revenue at Victoria's Secret would have to jump about 14%. That's just not realistic.
There are probably a few points of downside to the stock if holiday sales are disappointing, but there doesn't seem to be much upside either. I remain concerned about the bralette trend eroding the company's main lingerie business just like yoga pants took market share from mainline apparel. I would avoid the stock until Victoria's Secret can provide some support.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.