BBWI - Bath & Body Works: Execution Record So Far Is Positive

2023-09-25 03:39:11 ET

Summary

• Buy rating recommended for Bath & Body Works due to management's execution abilities, innovation in new categories, and success in the loyalty program.
• BBWI saw a drop in revenue in 2Q24 but gained market share and exhibited growth in all product categories compared to 2019 figures.
• Management's ability to expand into new categories, such as men's products, and maintain focus on core competencies is a strategic advantage.

Summary

I am recommending a buy rating for Bath & Body Works ( BBWI ) as I am encouraged by management execution abilities so far, driving the right innovation product to penetrate new categories, and also success in ramping up its loyalty program. These should drive a recovery in growth, and margins should improve as the business sees lesser costs of goods sold (transportation, R&D investments) and also lower IT costs due to the end of the separation.

Business

BBWI is a leading player in the personal care and home fragrance industry. With a primarily U.S.-centered supply chain, the business ensure the excellence of its products while maintaining accessibility. BBWI footprint extends far and wide, boasting over 1,800 company-operated stores in the United States and Canada, and an additional 400-plus locations abroad. They have also embraced the digital frontier as well, with its e-commerce platform, Bath & Body Works, offering a convenient way for customers to access offerings from the comfort of their homes.

Financials / Valuation

BBWI benefited from the covid lockdown/stimulus situation where consumer had extra discretionary income to spend, driving revenue from ~$5 billion to a height of $8 billion over the course of 3 years (FY18 to FY21). Like many consumer facing companies, BBWI saw a slowdown in revenue performance in FY22 due to the macroeconomic situation. Recent 2Q24 sales of $1.56 billion were in line with expectations but still represented negative growth (-3.6%). Traffic and ticket sales both dropped, contributing to the 3.6% decrease. Gross margin was 39.9%, with help from an increased merchandise margin rate year over year thanks to price deflation, higher average unit revenue, and lower transportation costs. While merchandise margin improved, it was more than offset by deleverage in other areas, such as buying and occupancy costs, which were hit hard by falling sales and rising costs associated with opening new locations. Technology expenses rose the most, reflecting both IT separation costs and strategic investments, as the company continued to reinvest in the business. Work on cost optimization mitigated this somewhat by reducing the amount of time and money spent on overhead at both the retail location and the corporate headquarters. As a result, BBWI's reported EBIT of $188 million was above the $178.1 million expected by consensus.

Based on my view of the business, BBWI should be able to return to positive growth terrain in FY25 after another year of slowdown in FY24 as growth normalizes from the COVID boost. My confidence in growth turning positive is based on the positive execution that management has demonstrated so far, especially in expanding into new categories, innovation capabilities, and success in driving loyal customers. As for margins, I expect improvement in margins (tracking against FY21/22 levels) as BBWI benefits from lower transportation costs, optimization in product investment (in product formulation as BBWI gathers more data via its loyalty program), and reduction in IT costs as it finishes the migration. I expect BBWI to continue trading at 10x forward PE, at a discount to peers like L’occitane and Coty, who are trading in the mid-teens range, given that BBWI is expected to grow slower (mid-single digits vs. 10+%). I note that BBWI is trading below its historical average, so there is room for multiples to re-rate higher if it is able to show faster growth than I expected.

Comments

Despite a drop in revenue in 2Q24, I believe there is reason to be optimistic about the company's future prospects based on its current course of action. Despite facing challenges such as sluggish growth in segments like home fragrance and hygiene products, it's encouraging to note that BBWI has gained market share in these areas year-to-date. Additionally, all product categories continue to exhibit substantial growth compared to 2019 figures, which bodes well for the company's long-term expansion. Long-term expansion should also be supported by management's continued emphasis on delivering on new product categories and innovations.

The key highlight is management’s execution ability to expand categories covered, which has been splendid so far. For example, BBWI launched a product line aimed specifically at men. This new product line experienced double-digit growth in sales in 2Q and remains one of BBWI's fastest-growing product lines and the fastest-growing category in body care. Not only are the sales from this new category expansion a positive thing, but my opinion is that it brings in more traffic to the store and also expands its consumer mind share among the male crowd. With the male traffic coming instore, BBWI would then be able to further gather purchase data to reiterate its product offering, such as men’s hair care and shaving, which management intends to bring in September. I also thought it was a smart strategy for BBWI to hold a limited launch of its fragrant hair care line in July, which was met with a positive customer response. This limited launch reduces the risk of holding up inventory but provides BBWI with the necessary data to reiterate the product before a full launch.

A large part of my optimism about BBWI's future outlook is that it seems like it can continue to innovate to penetrate other adjacencies while remaining focused on its core competencies. This is a distinction against simply innovating to grow into new categories but foregoing the core category, as the latter is where the baseline cash flow comes in. These innovative capabilities are supported by BBWI's competitive advantage in manufacturing; the majority (~85%) of BBWI's products are made in the United States, and half of those are made in its beauty park, which is located within a few miles of the company's headquarters. This allows BBWI to quickly put new products on store shelves in response to consumer demand, often within a matter of weeks and with minimal inventory risk.

And to your point, there's been a tremendous track record that the company has around innovation and newness. And despite any macro environment, the customer is always coming for newness and innovation and compelling seasonal assortment.

So the Beauty Park, which was one of the, I think, the significant competitive advantage that we had, obviously, well predates me and Julie, but it was quite prescient because the idea of having more than half -- actually, 85% of our manufacturing is done here in the United States and then over half of that in Beauty Park all within miles of our Columbus headquarters. Source: 2Q24 earnings

Last but not least, I anticipate a positive impact on P&L from BBWI as the company completes the lap on the launch of its loyalty program in August. It's important to note that since its inception, BBWI has helped fuel roughly 75% of US sales, making its membership of around 38 million people a vital component of this conversation. This is a huge sign that BBWI maintains its place in the minds of its target audience. I also see this as proof that people enjoy using BBWI's new products. I believe BBWI now has more data to further strengthen its innovation pipeline now that roughly three-quarters of US sales are coming from enrolled customers. Management claims that loyalty members account for the majority of BBWI's repeat business due to their high retention rates, total spending, and frequency of trips. From a customer lifetime value perspective, this certainly bodes well for BBWI.

Risk & conclusion

BBWI might not be able to continue innovating the right products to meet the needs of consumers in new categories. While the execution has been fine so far (e.g., in the men’s segment), it is prudent to recognize that BBWI is new to this field, and there is a risk that new products might not work. Continuous failures in innovating the right product will impact BBWI growth.

In conclusion, BBWI exhibits a positive track record in executing its strategies, instilling confidence in its future prospects. Despite a recent dip in revenue in 2Q24 due to macroeconomic factors, there are compelling reasons for optimism. BBWI's success in expanding into new product categories, cultivating innovation, and growing its loyal customer base through its membership program are promising indicators for a rebound in growth. Notably, BBWI's adept execution is evident in its swift expansion into segments like men's products, which have shown impressive sales growth. This expansion not only boosts sales but also attracts new customers and enhances brand recognition. Furthermore, BBWI's ability to innovate while maintaining focus on its core categories is a strategic advantage, supported by its efficient U.S.-based manufacturing capabilities. The completion of the loyalty program rollout augurs well for BBWI's profitability, given its substantial impact on sales and customer retention.

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