2023-09-01 04:55:55 ET
Summary
- I reiterate a hold rating as it is still in a "show me" situation and needs to prove its turnaround efforts.
- Actual earnings and sales for 2Q23 were below expectations, with no signs of improvement in underlying metrics.
- Potential upside if Victoria's Secret can achieve FY19 performance through current turnaround efforts.
Investment action
I recommended a hold rating for Victoria's Secret (VSCO) when I wrote about it the last time, as I expected the recovery to be non-linear and the best time to invest would be when the turnaround begins to show signs of success. Based on my current outlook and analysis of VSCO, I recommend a hold rating. VSCO is still in the "show me" situation where it needs to show the market that it is turning the business around. So far, performance has not been amazing, but I am certainly interested to see if the current growth initiatives work. If they work, I expect a narrative turnaround, which would be very positive for the stock. I note that the potential upside is amazing if VSCO can achieve FY19 performance through the current turnaround efforts..
Review
The consensus EPS estimate for 2Q23 was $0.26, so VSCO's actual EPS of $0.24 was below expectations. Sales were down 6.2%, which was below management's mid-single-digit guide and the consensus expectation of a decline of 5.5%. Deeper analysis revealed that underlying metrics showed no signs of improvement. SSS continues to struggle, having dropped by 11%. Management has pointed to weakening sales trends in North America, where they have seen a decrease in foot traffic, average basket size, conversion rates, and AURs compared to the same time last year across both brick-and-mortar and online channels. This SSS performance was made worse by the fact that the overall intimates market saw a sequential improvement, from a hsd (high-single-digits) % decline in 1Q to a msd (mid-single-digits) % decline in 2Q. Meanwhile, VSCO's same-store-sales decline of -11% in 2Q was flat compared to 1Q, indicating that VSCO's SSS trend was below the market average. For what it's worth, the bright spot is that VSCO is still seeing growth internationally, with 2Q growing 26%. However, as of FY23, 62% of VSCO's revenue still comes from North America, so I can't say I'm too thrilled by this development.
So what do we expect from here? In my opinion, VSCO still has to prove to investors that it can turn its business around. Management was optimistic about the future based on the trends they observed in August. The reimagined PINK merchandise assortment, which began shipping at the end of August, has been particularly well received. Sales in August were up from July, the second quarter, and the spring as a whole, management said, so that's good news. I take these as potential indicators that customers are starting to take notice of VSCO's growth initiatives. I'm also looking forward to a couple of initiatives that, if successful, could shift perceptions about how well current management strategies are being implemented. First of all, VSCO is launching new digital technology capabilities like a loyalty program and an at-home try-on feature called AdoreMe. The second, and by far the most important, is the premiere of the Victoria's Secret World Tour on September 26. The return on this investment is difficult to predict, but I believe it is necessary to improve the company's public profile. My logic is doing something is better than doing nothing.
Valuation
Author's work
As this is a turnaround situation, I modeled to figure out what the potential upside is from here. I used VSCO FY19 (pre-COVID) performance as a benchmark for my assumption. Assuming VSCO is able to turn around the business and achieve the same revenue level of $8.1 billion and 4% net margin in FY26, what is the company worth? The variable factor is what multiple VSCO should trade at, and I think the current multiple of 7x forward PE is the right multiple when compared against other specialty retailers. Looking across the peer group, VSCO has a similar growth and margin profile but a much larger revenue size. However, VSCO also has a much larger leverage ratio, which I think deserves a discount to the median multiple (7.6x) that peers are trading at.
Risk and final thoughts
Near-term execution is extremely crucial for VSCO. Failure to do so could further cripple the stock sentiment. This risk is further elevated with the current economy situation where consumers' confidence is clearly not in the best shape. The US economy falling into recession would definitely impact the share price.
My recommendation for VSCO remains a hold rating. The company's ongoing turnaround efforts necessitate tangible results before a more decisive investment stance can be taken. While recent performance fell short of expectations, I'm intrigued by potential growth initiatives and the positive reception of reimagined merchandise. The upcoming launch of digital technology features and the Victoria's Secret World Tour holds promise for changing perceptions. Valuation analysis suggests upside potential, assuming a successful turnaround, with a suitable multiple of 7x forward PE.
For further details see:
Victoria's Secret: Turnaround Efforts Need To Show Results