BBWI - Bath & Body Works: Great Execution And Performance

2023-12-23 00:29:11 ET

Summary

• BBWI reported better-than-expected sales and gross margin expansion in Q3 2024.
• The company's revenue growth is tracking well against management's guidance.
• As the macro situation improves in 2024, it bodes well for BBWI growth.

Summary

Readers may find my previous coverage via this link . My previous rating was a buy, as I was encouraged by Bath & Body Works ( BBWI ) efforts to turn around the business. Their execution was great, and they were also driving the right product innovations. My buy thesis did well and was well reflected in the share price movement (now at $43 vs. my previous price target of $40.80). I am reiterating my buy rating for BBWI, as I am very positive about the 3Q24 performance and the growth outlook ahead. I expect CY24 to be a year of growth recovery as the macro situation eases and management continues their strong execution.

Financials / Valuation

In the recent 3Q24 , BBWI reported sales of $1.6 billion, beating consensus estimate of $1.55 billion. 3Q24 sales performance tracked better than my FY23 estimate of -4% growth previously. Even better, gross margin came in at 43.7%, expanding by 140 bps, beating even consensus estimate of 42.5%. Margin expansion was driven by improved merchandise margins driven by differentiation benefits, lower product costs, and reduced transportation costs. While there were some offsets due to sales deleverage, overall EBIT still improved to $221 million, beating consensus estimate of $183 million. EBIT margin also came in higher at 14.1%, beating consensus estimate by 230 bps.

Based on my view of the business, BBWI is tracking well against my expectations, especially on the margin front. 3Q24 performance reinforced my view that revenue growth is tracking well against management’s guidance (-2.5% to -4%), and I expect it to come in at the top end of the range. FY25 (CY24) will be the year of growth recovery, as I expect the macro situation to recover and BBWI to continue showing great execution. BBWI’s ability to improve margin is evident in the quarter, and my assumptions for margin improvement remain the same: 11% in FY25 and 12% in FY25. However, I now expect BBWI to trade at 13x forward PE, its historical average, instead of 10x forward PE, as the business has shown that it is on track for growth recovery. I believe that investors have recognized management’s execution abilities and are pricing in that aspect. If we look at the valuation chart, forward PE surged sharply to 13x almost immediately post-earnings, which is a positive sign of the market giving credit to BBWI performance. All in all, my revised model has a target price of $53.

Comments

I remain buy-rated for BBWI, as the business did better than I expected. Addressing the issue of the cited deceleration in traffic trends in 3Q24, I don’t think there is much to worry about. In context, management mentioned that as the quarter progressed from August into September and October, traffic dipped into the negative zone for the first time this year. They also mentioned that the business continues to be pressured by the macro backdrop, as evidenced by lower basket sizes and lower conversion rates. I remind readers not to forget the fact that BBWI had lapped the launch of its loyalty program, which makes the y/y comps different vs. 1H23. Also, BBWI saw improving trends with roughly flat y/y sales in August, driven by its strong Halloween performance. Given the weak macro situation, consumers might have pulled forward their demand as they took advantage of the promotion. For perspective, Halloween sales were up 5% on a y/y basis. Finally, from a quarter perspective, BBWI still saw positive traffic growth and noted sequential improvement in October. If one were to step back and digest this, it seems like the growth headwind here is largely macro-driven and to a minor extent due to a normalized comp base in FY22. These headwinds do not indicate any signs of weakness in the BBWI business on a standalone basis. Their promotion strategy also worked well, as seen by the 5% growth in Halloween sales.

In fact, I highlight that management execution was splendid in the quarter. While the quarter traffic trend was soft, management managed to balance traffic with price increases. This was well seen in the financials, where revenue declined but margins improved, leading to a beat at the bottom line. Notably, this was done without a significant increase in promotions. The way I see the current growth trajectory, it seems like all BBWI needs is a recovery in the macro situation, which will improve consumer confidence. Positively, I think the time for the macro environment to improve is near. Most readers would have read the news that the Fed is inclined to cut rates in the coming year. I believe this is a huge indication that the macro environment has greatly improved since the start of 2023. When rates normalize, the implication is that inflation has normalized, which is a positive thing for consumer spending. Remember that BBWI has a history of AUR growth in the low-single-digit range (in line with inflation). I expect AUR to recover to the same growth trend as the macro situation further improves.

Looking ahead, my view of the growth path for CY24 is similar to that of management, where they expect positive sales growth in 2CH24. Aside from the macro situation recovering, BBWI is also going to benefit from the easy comp base after two years of softness. These, along with management's continuous and strong execution in balancing pricing increases against traffic (which improves margin), should drive earnings growth higher than sales growth. Moreover, BBWI is also going to benefit from the rollout of adjacent categories such as men’s, laundry, and hair care, which further amplifies the negative comps tailwind in terms of growth.

With a history of filing for bankruptcy, the ongoing concern with BBWI is whether it has sufficient liquidity to support its growth. As of 3Q24, BBWI has $412 million in cash and around $4.5 billion in debt (excluding operating leases). These translate to a net debt position of $4.1 billion, or 2.7x net debt to EBTIDA. This seems high from a historical perspective, but the good news is that $3.8 billion of debt is going to mature in 2027 and beyond, so BBWI has sufficient time to pay down debt or refinance it. BBWI's working capital position also continues to improve. They managed to reduce inventory by 5% and indicated there is no need to stock up on inventory (which hurts FCF) as inventory levels are well-positioned going into the holiday season. Using consensus FY25/26 estimates, BBWI is expected to generate around $1.6 billion in FCF. This would reduce the net debt position to just $2.5 billion, or 1.5x in FY26, based on consensus FY26e EBITDA estimates. At 1.5x, it would be in line with the historical leverage ratio. As such, I don’t see any liquidity risk.

Risk & conclusion

A pivotal point in my thesis is that the macro situation will improve in CY24 (as indicated by the Fed positioning). However, this may not turn out as I expected. Rates could definitely go higher and stay high for longer than expected. In this case, consumer spending will continue to stay weak, impacting BBWI’s growth.

To conclude, I continue to recommend a buy rating for BBWI. I expect 2024 to be a year of growth recovery as the macro environment recovers and management continues to execute well. Notably on execution, I like the fact that management managed to balance traffic and pricing without aggressive promotions. As the Fed cut rates, it should bode well for consumer confidence and BBWI's growth trajectory. Additionally, the company's liquidity position appears sound, mitigating concerns about liquidity.

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