BBWI - Bath & Body Works Long-Term Debt Yielding 8.5%

2023-03-28 07:36:45 ET

Summary

• Bath & Body Works is a specialty retailer that faced sales headwinds in 2022.
• The company's cash flow generation presents the strongest case for fixed-income investment.
• Share buybacks could hinder credit upgrades.

Bath & Body Works ( BBWI ), formerly known as L Brands, is a retailer centered arounds soaps, lotions, and fragrances. The company's debt, which still trades under the L Brands name, has seen its prices decline and yields rise under the combination of a rising rate environment and junk credit rating. The company's 2035 maturing bonds are now yielding close to 8.5%, 130 basis points higher than the benchmark yield . The company's cash flow generation makes it a good candidate for a fixed income investment, but some metrics require further monitoring.

Bath & Body Works sales cooled in 2022 compared to the year prior and cost of sales actually increased compared to 2021. Those distortions led to a decline in operating income of greater than $600 million to $1.3 billion. The company's operating income was still four times higher than its interest expense, demonstrating that Bath & Body Works can cover its debt service costs with profits.

Bath & Body Works balance sheet shows a relatively static 2022. The company maintained its long-term debt levels at $4.8 billion. The only significant variance on the balance sheet is the $700 million drop in cash. This drop reverberates through total assets and shareholder equity. Since property and equipment did not rise substantially, it makes it difficult to determine where the cash went, until examining the statement of cash flows.

Bath and Bath Works is generating sufficient cash to reduce its long term debt. Free cash flow dropped in 2022, led by a decline in operating activity cash, to just over $800 million. If the company is generating strong cash flow, where did the money go? In 2021 and 2022, the company returned over $3.5 billion to shareholders, more than $3.2 billion of that was in the form of stock buybacks. The remaining portion was paid in the form of dividends. If the company had opted to reduce debt, it would likely have an investment grade credit rating today.

Looking into the future, Bath & Body Works debt wall is fairly manageable. The company's next debt maturity of $317 million comes due in July of 2025, followed by a debt maturity of $283 million in January of 2027. Existing operating performance should generate the free cash flow necessary to pay these maturities off with cash if the company chooses not to refinance.

If Bath & Body Works should find itself locked out of the credit markets and unable to refinance, the company does have $509 million in borrowing capacity under its ABL facility combined with $1.2 billion in cash on hand, creating over $1.7 billion in liquidity. While the ABL facility is limited to inventory purchases, the company can simply utilize the ABL to buy inventory and re-route operating cash/ cash on hand to pay down debt.

The one sticking point/risk to bondholders is the excessive use of cash to buy back stock. The transaction is designed to bolster the stock price, but as seen here, it weakens the company's balance sheet. If buying back stock was unilaterally a good thing, it would have certainly helped fellow retailer Bed, Bath, and Beyond . Despite my hang-up on share buybacks, income investors should feel confident that the company is going to be able to return principal to its bondholders.

CUSIP: 501797AL8

Price: $87.94

Coupon: 6.875%

Maturity: 11/1/2035

Yield to Maturity: 8.447%

Credit Rating (Moody's/S&P): Ba2/BB

For more information on this bond, check out its FINRA page .

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