2023-09-01 03:30:00 ET
Summary
- Victoria's Secret has experienced a significant decline in its stock value, losing about 50% year-to-date.
- The company reported a net loss of $1 million for the most recent quarter, with operating income and net sales also decreasing.
- The poor performance can be attributed to weak consumer confidence and a challenging macroeconomic environment, leading to decreased demand and margin compression.
- While the price multiples are low, the firm may just be a value trap.
- For these reasons, we assign it a "sell" rating.
Victoria's Secret & Co. ( VSCO ) operates as a specialty retailer of women’s intimate, and other apparel and beauty products worldwide.
The firm's stock has been in the spotlight for the wrong reasons in the past months and quarters. The company has lost about 50% of its market value year-to-date, while the broader market has gained almost 18%.
In today's article, we will be discussing the latest earnings results , and we will be looking at the macroeconomic developments in the recent past to gauge how they may have been influencing VSCO's financial performance this quarter and how they may do so in the near future.
Q2 Earnings
Many retailers and firms in the consumer discretionary sector have been performing relatively poorly in the past quarter, which is also reflected in their stock price developments. Most of them have been concerned about the health of the U.S. consumers and their spending behaviour now just in the recent months, but also looking ahead. Among others, Macy's ( M ) have issued a cautious guidance , leading to a widespread sell off within the industry.
Victoria's Secret is no exception from the recent poor performance. For the most recent quarter, VSCO has reported a net loss of $1 million, compared to the net income of $70 million for the second quarter of 2022. Operating results have also significantly deteriorated, with operating income falling to $26 million from $98 million in the prior year. Not only the bottom line results have been hit hard, but also the top line as net sales have fallen to $1.427 billion for the second quarter of 2023 from $1.521 billion in Q2 2022, representing a 6% decrease year-over-year.
In our opinion, these results can be largely explained by a few key macroeconomic indicators, for example, by the consumer confidence levels in the United States.
Consumer confidence is often regarded as a leading economic indicator, which can help analysts and investors gauge how the spending behaviour of the consumer may change in the near future. The following chart shows the sentiment of the U.S. consumer for the past 12 months.
We can clearly see that the confidence levels in the first and second quarters have remained low. This may be an indication that consumers are more reluctant to spend larger sums on non-essential, discretionary and durable items as they are not so certain about their financial futures and the health of the economy overall. In fact, this is reflected in the results of many retailers in Q2, including Macy's, Foot Locker and even Victoria's Secret. The top line results for many retailers have been indicating that the demand for their products is relatively weak. At the same time, inventory management problems, steep discounting and inflationary pressures have been putting downward pressure on their margins and their bottom line results.
As the consumer sentiment has started to improve significantly in the third quarter, we believe that it will have a positive impact on the firms' financial performance starting from later this year, or early next year. As it is a leading indicator, its signals are likely to play out with a delay. Improved consumer confidence readings now means a potentially positive change in the spending behaviour in a few months or quarters ahead.
Looking forward, there will be two more important measures to keep an eye on: inventory levels and accounts receivable.
Inventory
Inventory management has been in the spotlight for many retailers in the past quarters. VSCO's inventory has also sharply increased in 2021 and 2022, but it has started coming down already. Looking forward, we would like to see this trend continuing, however we have to note that it may only be achieved by steep discounts, leading to a continued compression of the margins.
Accounts receivable
Accounts receivable is an important line item to check, when we want to make sure that sales figures are not artificially inflated. If accounts receivable grow at a faster rate than sales, it may be an indication that the firm is selling more or credit or has changed revenue recognition policies, in order to "pull demand forward" from future periods. Fortunately this is not the case for VSCO. The recent drop in sales has been also accompanied by a drop in the receivables.
Looking forward, it is important to monitor that this relationship continues holding up.
Capital allocation
Victoria's Secret has also announced a new share buyback program back in January as a part of their capital allocation. This has been completed in two steps. In both Q1 and Q2, the firm has repurchased shares for $125 million. While the amount is relatively large compared to the firm's current market value, these buybacks had no meaningful positive impact on the share price. Looking forward, we do not expect another share repurchase program in the near term, as the firm's cash balance has been gradually declining, and the financial performance does not appear to be strong enough to afford another round of repurchases in the near term.
At the same time, the company's total long term debt has been gradually increasing, which may cause some concerns, especially in the current high interest rate environment. For this reason, one may question if share buybacks are really the most effective use of cash at this time.
Guidance
Another reason for the sharp decline in the stock price has been the relatively pessimistic outlook. The firm is expecting a deterioration of the financials for both Q3 and the full year.
The Company is forecasting third quarter 2023 net sales to decrease in the low- to mid-single digit range compared to last year’s third quarter net sales of $1.318 billion. At this forecasted level of sales, adjusted operating loss for the third quarter of 2023 is expected to be in the range of $45 million to $75 million. Adjusted net loss for the third quarter of 2023 is estimated to be in the range of $0.70 to $1.00 per diluted share.
The deterioration is likely driven by the expected continuation of weak demand combined with inflationary pressures and further rate hikes by the Fed.
Valuation
When looking at a set of traditional price multiples, we can see that VSCO appears to be trading at a significant discount compared to the consumer discretionary sector median.
If we narrow down the peer group to the apparel retail industry only, we can still see that VSCO is valued relatively cheap compared to the rest of the industry.
Does this mean however that it is a buy? In our opinion, no. Low price multiples are not always indicative of great value investments. Sometimes they may just be a value trap. In this case, we believe that VSCO may just actually be one. The firm's competition over the years has significantly increased, while its dominance has faded. In our opinion, currently both the macro- and microeconomic environment is too uncertain to accurately gauge, whether a turnover story is possible for the company in the near term.
Conclusions
Financial metrics have been gradually deteriorating, with both top- and bottom line results getting worse.
Improving consumer confidence in Q3 may positively impact the firm, but the uncertainty looking forward is quite high. We do not believe that VSCO has a moat or a competitive advantage against its peers.
The valuation may be low according to the traditional price multiples, but the firm may just be a value trap.
For these reasons, we do not want to have VSCO in our portfolio and we assign it a "sell" rating.
For further details see:
Victoria's Secret: It May Just Be A Value Trap