Although we're trimming the company's fair value estimate, it still possesses a wide economic moat, with pricing power and brand loyalty--and shares are undervalued.
By Bridget Weishaar | 11-17-16 | 01:47 PM | Email Article

 L Brands's third-quarter top-line and margin performance continued to be muted as product line exits, new marketing initiatives, and ongoing beauty repositioning efforts are in investment stages. We plan to lower our $78 fair value estimate by about two dollars as management indicated that the impact of category exits will likely worsen, bearing a low-single-digit negative Victoria’s Secret comp impact in the fourth quarter and high-single-digit negative VS comp impact in the first half of next year. One-time headwinds will also pressure fiscal 2016 results, and we estimate that the net negative impact of investment in China, the Fifth Avenue flagship store, foreign exchange, higher interest, and lower share count is about $0.26 this year. This will likely lead us to lower our fiscal 2016 earnings per share estimate to around $3.69 versus our prior estimate of $3.72.

Bridget Weishaar is a senior equity analyst for Morningstar.

In the long term, we still believe that the company possesses a wide economic moat, with pricing power, brand loyalty, and some barriers to entry coming with the unique characteristics of the intimate apparel space (difficulty of bra production, large SKU count due to sizes, and customer prioritization of comfort, fit, and quality over price). We view recent strategic efforts as leaving the company even better-positioned to focus on its core strengths and increase return on investment. In our opinion, L Brands will be able to achieve average annual mid-single-digit growth over the next five years and have operating margin rebound to the 17% three-year historical average versus our expectation for just north of 16% this year. That said, we caution that strategic actions, investment in China, bralette mix shifts, and international headwinds will likely continue to temper performance over the next two to three quarters.

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