AEO - Victoria's Secret: Relatively Cheap Valuation But Unexciting Prospects

2023-08-08 03:54:30 ET

Summary

• Victoria's Secret's turnaround plan has yet to deliver results.
• Rebranding strategy could be too little too late, and lack of a strong differentiation opens question marks over sustainability of their market leadership position.
• Competitive risks significant.

Premium lingerie brand Victoria's Secret's share price is currently trading at a discount, but a soft market positioning in a market with strong competitors suggests unexciting prospects which don't make the stock a buy.

Background

America’s biggest lingerie retailer Victoria’s Secret ( VSCO ) has had a tough few years with revenues and market share declining consistently. Sales and operating cash flows remain below pre-pandemic levels.

Although part of the decline is attributable to weak consumer spend on pricey non-essentials like Victoria’s Secret’s expensive lingerie due to ongoing macro challenges, the company’s long term revenue and market share decline is largely attributable to changing consumer preferences which Victoria’s Secret ignored . Scandals among the company’s top brass didn’t help either. The company’s market share of America’s women’s underwear market has shrunk from 32% to 24% between 2013 and 2018, and latest data suggest a market share under 20% , while competitors like Aerie (the underwear brand run by American Eagle Outfitters), have increased their market shares. Aerie’s market share has grown to over 6% of the U.S. women’s underwear market, up from less than 2% in 2015.

Transformation plan addresses consumer concerns but results remain elusive

As part of their multi-year transformation plan, Victoria’s Secret has made numerous changes to revamp their brand image including doing away with their iconic supermodel ‘angels’ and replacing them with VS Collective (a group of diverse, size-inclusive brand ambassadors such as Priyanka Chopra, Paloma Elsesser and Megan Rapinoe), and reinventing their product range to include plus-sized and maternity offerings. Their upcoming fashion show in September (after a four year hiatus), will be headlined by rapper Doja Cat in contrast to previous shows which heavily featured some of the world's highest paid supermodels.

Operationally, their rebranding strategy partly focuses on expanding and redesigning their retail stores and increasing penetration in digital channels. The acquisition of direct-to-consumer brand Adore Me, which closed this year, not only captures market share from an increasingly formidable player, but could also bolster their eCommerce capabilities . Digital sales currently account for 10% of sales.

The transformation plan has yet to deliver any positive results as evidenced by continued revenue declines over the past few years. Victoria’s Secret’s top line has continued to trend down over the past few quarters.

Their bottom line has also deteriorated over the past few quarters, with net income sinking to just $1 million during the April 2023 quarter from $81 million the same quarter a year earlier due to increased promotional activity which did not translate into sales growth.

Near term prospects are not very optimistic with management expecting sales for the coming year to be flat or down mid-single digits compared to last year, in contrast to Aerie which is expected to Aerie Looks To Double Sales To $2 Billion As Shoppers Ditch Victoria's Secret sales to $2 billion in 2023.

Profitability is expected to slide down as well; adjusted operating margin is expected to drop to 5%-6% for the year compared with nearly 9% last year. Free cash flows for the year are projected at between $150 million - $200 million.

Rebranding strategy too little too late, and lack of differentiation a concern

It could be argued that transformation plans generally take time to deliver results (the company began their brand revamp around four years ago) however even assuming the plan helps reverse shrinking revenues, it remains to be seen if Victoria’s Secret could maintain its lucrative, market leading position. Victoria’s Secret's rise to market leadership partly rested on a premium positioning centered around hyper-sexualized and glamorous lingerie, marketed through glitzy fashion shows featuring highly paid supermodels, a highly differentiated market positioning few rivals could match.

Their rebranding effort however could be too little too late with rivals like Aerie featuring a greater diversity of models that are more relatable to women since 2014, roughly five years earlier than Victoria’s Secret who began abandoning photoshopped supermodels around 2019. More crucially, their rebranding strategy arguably lacks a strong differentiation, and the new brand is not much different compared to rivals like Savage X Fenty, and Kim Kardashian’s Skims in terms of market positioning, and to some extent, product offering as well. With Victoria’s Secret playing catch up rather than leading the way, further market share erosion cannot be ruled out and may limit earnings prospects as well, barring any change to strengthen their market positioning. For instance, there are views that Victoria’s Secret may be better off maintaining their highly differentiated sexy, glamorous brand image but evolved to cater to modern consumer demands for greater diversity.

Risks

Competitive risks

Brands including Aerie, Savage X Fenty, and Skims are just a few of the brands opportunistically capitalizing on Victoria’s Secret’s struggles. With Victoria’s Secret’s new brand image arguably lacking a strong differentiation against new players, the company may struggle to regain lost market share and their turnaround could be an uphill climb. Skims notably has considerable advantages including the backing of an influential, billionaire celebrity, and a healthy brand reputation. A bigger warchest after its latest funding round which raised $270 million could further accelerate their growth ambitions. For perspective, Victoria's Secret has less than $ 150 million in cash according to is latest quarter but to be fair Victoria's Secret is generally operating cash flow positive while Skims, whose financials are unknown at this point, may possibly be burning cash.

The company faces considerable competitive risks outside North America, particularly in China - a key growth market - from brands like Ubras and Neiwai. International sales currently account for just 10% of revenues but is a key business priority for Victoria's Secret. Stiff competition could limit market share gains and dent earnings prospects.

Conclusion

Victoria’s Secret has limited analyst coverage.

With a forward P/E of 8.4 , Victoria’s Secret is trading at a discount to the sector median (15.7), as well as to peers like American Eagle Outfitters (forward P/E 14.5 ).

Victoria’s Secret also appears to be trading at a discount compared to four-year old Skims which has a market value of $4 billion (as of its latest funding round this year) compared with $1.5 billion for Victoria's Secret.

Based on FCF, Victoria’s Secret’s market valuation of $1.5 billion is just 7x their projected FCF of $200 million for FY2023 compared with roughly 15x for American Eagle Outfitters. The discount looks enticing for a market leading player but lack of encouraging results from their transformation plan so far, and as of now, a relatively uncompelling market positioning in the face of increased competition from newer, and notably celebrity-backed players doesn’t bode well and may limit market share gains and earnings prospects barring a major change to their strategy. The stock may be a hold for investors willing to tolerate the risks.

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