Transitory Expenses Position Bath & Body Works’ Brand for Long-Term Margin Recovery

We don’t plan a material change to our $82 fair value estimate for narrow-moat Bath & Body Works after third-quarter results and view shares as undervalued, even after a 20%-plus post-print pop. EPS of $0.40 were ahead of the firm’s projected $0.10-$0.20, and we estimate 20%-30% of the outperformance was from a lower share count. A 13% operating margin remains depressed from higher expenses across the income statement. For one, the gross margin contracted 770 basis points, to 42% (better than the 40% that was expected) hindered by inflation and promotion. SG&A costs couldn’t escape deleverage (sales fell 5%), up 410 basis points to 30%, weighed by efforts undertaken to improve technology after its divorce from Victoria’s Secret. Like numerous other retailers, Bath & Body is not immune to economic headwinds, and we think the firm is set up for further sales declines in the fourth quarter, along with an operating margin of around 20% (down 400 basis points versus 2021) and a 33% decline in EPS (at the midpoint of guidance). This still marks fourth quarter’s potential sales 35% ahead and EPS 10% above 2019 levels.