L Brands Up 50% In 3 Months: Will The Rally Continue In 2018?

Shares of L Brands, Inc. LB are riding high on its efforts to streamline Victoria's Secret business, revamp business by improving store experience, localizing assortments and enhancing direct business. In the past three months, the company's shares have gained 50%, outperforming the industry's growth of 26.4%. However, the declining bottom line and margins are primary hindrances for the stock at the moment. Let's delve deeper.

Hidden Catalyst

We believe that L Brands' sustained focus on cost containment, inventory management, merchandise, and speed-to-market initiatives has kept it afloat in a competitive environment. This is evident from its positive earnings surprise history. In eight of the trailing nine quarters, it has outperformed the Zacks Consensus Estimate by an average of 7.5%.

We believe that the company's operational efficiencies, together with its new and innovative collections, bode well. Further, the company's foray into international markets is likely to provide long-term growth opportunities and generate increased sales volumes. Management now projects earnings in the band of $3.05-$3.20 per share for fiscal 2017 compared with the previous guidance of $3.00-$3.20.

The big take away from the third-quarter results was robust top-line performance. Revenues surpassed the consensus mark for the first time in five quarters and also increased year over year after witnessing a decline of 7% and 5% in the first and second quarters, respectively. The company reported net sales of $2,617.8 million, up 1% from the prior-year quarter.

L Brands continues to revamp business by improving store experience, localizing assortments and enhancing direct business. We believe these measures facilitate it to generate incremental sales and increase store transactions through higher conversion rate. The company is repositioning its La Senza brand by focusing on the younger generation and providing fashionable assortments at a reasonable price.

Hurdles to Cross

L Brands' dwindling bottom-line remains the primary concern for investors. A look at the company's performance in fiscal 2017 unveils that earnings per share fell 29%, 44% and 31% in the third, second and first quarter, respectively. Management projects earnings in the band of $3.05-$3.20 per share for fiscal 2017, which is well below fiscal 2016 and 2015 earnings of $3.74 and $3.99, respectively. Moreover, the company now envisions fourth-quarter earnings in the range of $1.95-$2.10 compared with the prior-year quarter earnings of $2.03.

Gross margin, an important financial metric, which gives an indication about the company's health has shown constant deceleration in the past few quarters. In the first, second and third quarters of fiscal 2017, adjusted gross margin contracted 320, 120 and 190 basis points (bps) to 37.1%, 37.3% and 37.8%, respectively primarily due to buying and occupancy expenditure deleverage during the quarter. It was further impacted by fall in merchandise margin rate. We noted that gross margin has contracted 230 bps, 190 bps, 180 bps and 170 bps in the fourth, third, second, and first quarters of fiscal 2016 to 43.3%, 39.7%, 38.5% and 40.3%, respectively. Further, management anticipates gross margin to deteriorate year over year during the fourth quarter as well as fiscal 2017.

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