Company Reports

We believe Bath & Body Works has carved out a solid competitive edge in the sizable addressable markets in which it operates. The company’s strong brand intangible asset is supported by its leadership position across the bath and shower and candle air freshener industries in recent years, which has been bolstered by BBW’s quick response to consumer trends. Quantitatively, the narrow moat is reinforced by a 48% average return on invested capital excluding goodwill that we expect the business to generate over the next decade, well ahead of our 8% weighted average cost of capital estimate.

We don’t plan any material change to our $73 per share fair value estimate for narrow-moat Bath & Body Works, or BBW, after considering its first-quarter results and a modest upward nudge to its full-year outlook. We view shares as undervalued after a post-print double-digit drop and believe the market is focusing on near-term profit pressure, with higher marketing costs in the second quarter expected to lead to year-over-year operating margin contraction. Moreover, with the full-year outlook largely unchanged, we think investors are concerned that second-half operating margins could be flat versus last year (around 20.5%), indicating stalled progress back to the 20%-plus full-year metrics the firm historically achieved. BBW lifted the low end of its prior 2024 outlook, now calling for a sales decline of 2.5% to flat and EPS of $3.05-$3.35 (up a nickel), in line with our preprint forecast that included a sales decline of 1.9% and EPS of $3.16. As such, we don’t surmise much change to our near-term outlook.

We are lowering our Uncertainty Rating for narrow-moat Bath & Body Works to High from Very High, consistent with our quantitative methodology. A lower Uncertainty Rating signals that a narrower margin of safety is generally required for shares to appear attractive. While the rating is primarily driven by the volatility in the share price, it also considers the firm's fundamental exposure to the economy and economic cycles. We believe Bath & Body Works faces similar risks to most other consumer discretionary retailers, including the impact of inflationary pressures, employment levels, wage growth, and low barriers to entry. Additionally, on the input side, less favorable changes to trade where portions of the supply chain are located could hurt top-line growth and margins (although most inventory is produced in its Beauty Park facilities in the US). Favorably, our current risk assessment incorporates the mitigation of share erosion based on continued investment in innovation and brand elevation, which should help maintain a solid pricing structure across categories. The change in the Uncertainty Rating doesn’t sway our $73 fair value estimate, which is predicated on long-term sales growth of 3% and a return to 20%-plus operating margin performance.

We believe Bath & Body Works has carved out a solid competitive edge in the sizable addressable markets in which it operates. The company’s strong brand intangible asset is supported by its leadership position across the bath and shower and candle air freshener industries in recent years, which has been bolstered by BBW’s quick response to consumer trends. Quantitatively, the narrow moat is reinforced by a 49% average return on invested capital excluding goodwill that we expect the business to generate over the next decade, well ahead of our 8% weighted average cost of capital estimate.

Narrow-moat Bath & Body Works (BBW) delivered a strong fourth quarter, with sales and EPS ahead of our forecast. Fourth-quarter sales rose 1%, to $2.9 billion, a touch above our $2.8 billion estimate and more than 30% over 2019, despite the ongoing normalization of demand in certain categories. EPS of $2.06 exceeded our $1.76 projection, aided by a gross margin of 45.9% (versus our 44% estimate) that benefited from a 290-basis-point uptick in merchandise margin stemming from higher average unit retail and cost deflation. However, the initial sales and EPS outlook for 2024 sent shares lower by a mid-single-digit rate. With 2024 facing a 100-basis-point headwind from lapping an extra week in 2023, like-for-like sales are set to be down 2% to up 1%, which will still represent above-40% growth over a 5-year period. In our opinion, a stalled operating margin at 17% was the real surprise, as it was well below our 19% forecast.

We believe Bath & Body Works has carved out a solid competitive edge in the sizable addressable markets in which it operates. The company’s strong brand intangible asset is supported by its leadership position across the bath and shower and candle air freshener industries in recent years, which has been bolstered by BBW’s quick response to consumer trends. Quantitatively, the narrow moat is reinforced by a 58% average return on invested capital excluding goodwill that we expect the business to generate over the next decade, well ahead of our 8% weighted average cost of capital estimate.

Although narrow-moat Bath & Body Works delivered third-quarter sales that were in line with the firm's prior guidance—at $1.6 billion, down 3%—the profitability of the enterprise impressed. The firm delivered an operating margin of 14%, up 150 basis points over last year and well ahead of the sub-12% prognosis from consensus (FactSet). Importantly, this lift was largely attributable to the gross margin rise to 43.7%, practically in line with prepandemic third-quarter marks, buoyed by improving merchandise margins (200 basis points) as a result of successful product launches that continue to cater to customer trends. While BBW nudged the full-year outlook lower to include a sales decline of 2.5%-4% (from 1.5%-3.5% prior) and raised its EPS outlook to $2.90-$3.10 (from $2.85-$3.15), metrics are largely in line with our 2% sales decline and $3.07 EPS preprint estimates. As such, we don't plan any material change to our $78 fair value estimate and view shares as extremely attractive.

We believe Bath & Body Works has carved out a solid competitive edge in the sizable addressable markets in which it operates. The company’s strong brand intangible asset is supported by its leadership position across the bath and shower and candle air freshener industries in recent years, which has been bolstered by BBW’s quick response to consumer trends. Quantitatively, the narrow moat is reinforced by a 54% average return on invested capital excluding goodwill that we expect the business to generate over the next decade, well ahead of our 8% weighted average cost of capital estimate.

Narrow-moat Bath & Body Works, or BBW, felt the pain of spending normalization in the second quarter. While sales of $1.56 billion kept up with the firm’s forecast for a low- to mid-single-digit decline, the downtick led to cost deleverage, resulting in a 12% operating margin (down nearly 300 basis points). Although sales were 40% higher than the same period in 2019, selling, general, and administrative costs provided a stall in profitability. However, the biggest expense headwind stemmed from technology costs, some of which should prove transitory given that this spending was necessitated a result of BBW’s split from Victoria’s Secret. Thankfully, the gross margin held up well, at 40% thanks to increased average unit revenue and improved merchandise margin, which experienced its first uptick in over two years. In our opinion, this implies the brand intangible asset is holding firm, indicated by consumer willingness to forgo discounting despite widespread concern around discretionary spending.

We believe Bath & Body Works has carved out a solid competitive edge in the sizable addressable markets it operates in. The company’s strong brand intangible asset is supported by its leadership position across the bath and shower and candle air freshener industries in recent years, which has been bolstered by BBW’s quick response to consumer trends. Quantitatively, the narrow moat is reinforced by a 56% average return on invested capital excluding goodwill that we expect the business to generate over the next decade, well ahead of our 8% weighted average cost of capital estimate.

We don’t plan to alter our $78 fair value estimate for narrow-moat Bath & Body Works, or BBW, after digesting its first-quarter results. Sales fell 4% to $1.4 billion, in line with prior guidance, and place BBW on track to deliver $7.4 billion in sales in 2023, representing a 3% decline (but still a 43% rise versus 2019). Even with consumers facing persistent inflation, BBW noted it had yet to experience any trade down patterns from its customer base or differences in spending between socioeconomic groups, displaying consumers’ willingness to spend on items that are perceived as affordable luxury. Although occupancy deleverage hurt profitability, its ability to raise prices strategically and maximize cost savings brought a 13% operating margin, in line with 2019’s comparable period. Even with BBW lifting its full-year adjusted EPS outlook to $2.68-$3.08, we think the current year’s operating margin appears to be stuck around 16%, hindered by investment into the business, expense deleverage, and raw material cost hikes that have failed to ease.

We believe Bath & Body Works has carved out a solid competitive edge in the sizable addressable markets it operates in. The company’s strong brand intangible asset is supported by its leadership position across the bath and shower and candle air freshener industries in recent years, which has been bolstered by BBW’s quick response to consumer trends. Quantitatively, the narrow moat is reinforced by a 57% average return on invested capital excluding goodwill that we expect the business to generate over the next decade, well ahead of our 8% weighted average cost of capital estimate.

We plan to lower our $82 fair value estimate for narrow-moat Bath & Body Works by a high-single-digit rate after digesting better-than-expected fourth-quarter results but a disappointing 2023 outlook. Fourth-quarter sales fell 5% to $2.9 billion, better than the roughly high-single-digit guidance, with unspecified declines in ticket and transaction levels, although this was still a 29% increase over 2019 sales. More significantly, operating margin was crushed, down 680 basis points to 22.6%, with most of the decline stemming from gross margin compression of 480 basis points. Gross margin suffered from weaker merchandise margin performance and expense deleverage as inflationary expenses persisted. EPS from continuing operations of $1.86 bested the firm’s $1.45-$1.65 guidance, but the quarterly outperformance wasn’t enough to offset a dour 2023 outlook in our valuation. Given the recent volatility in share performance, we plan to raise our Uncertainty Rating for BBW to Very High from High, consistent with our quantitative methodology.

On Dec. 8, New York-based hedge fund manager and activist investor Daniel Loeb of Third Point Management disclosed that his stake in narrow-moat Bath & Body Works, or BBW, had risen to 6%. In regulatory filings, Loeb expresses concern with how the board of directors has structured executive compensation, financial discipline, and investor communication. Specifically, Loeb complains that incentive-based pay to the firm’s executives fails to consider “important performance metrics” and recommends a refresh of the board. We suspect Loeb’s grievance may be with how BBW’s performance-based pay is partly linked to revenue growth relative to a designated peer group. In our view, while targets could be better refined to focus on long-term profitability (not revenue-based and relative to peers due to the focus on growth over profitability and ambiguity associated with defining a peer set), we see no existential issue with BBW’s overall governance. With respect to tenure, we believe the board is relatively fresh, with only two of its nine members having served for over five years.

We believe Bath & Body Works has carved out a solid competitive edge in the sizable addressable markets it operates in. The company’s strong brand intangible asset is supported by its leadership position across the bath and shower and candle air freshener industries in recent years, which has been bolstered by BBW’s quick response to consumer trends. Quantitatively, the narrow moat is reinforced by a 59% average return on invested capital excluding goodwill that we expect the business to generate over the next decade, well ahead of our 8% weighted average cost of capital estimate.

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.

On Nov. 2, narrow-moat Bath & Body Works tapped Gina Boswell to serve as CEO, following Andrew Meslow’s decision to step aside in March due to health reasons. The transition is set to take effect on Dec.1, and interim CEO Sarah Nash will reassume her role as chair of the board. Boswell boasts extensive leadership and business development experience from her career at high-profile consumer focused firms including Avon, no-moat Ford, and wide-moat Estee Lauder. More recently (2011-19), Boswell successfully rose through the ranks at wide-moat Unilever after the firm acquired Alberto Culver Company (manufacturer of hair, skin, and beauty products), where she had served as president of global brands. Throughout her years at Unilever, she was named executive vice president of personal care (North America), head of Unilever U.K. and Ireland, and president of customer development, Unilever U.S.A, most recently. We believe Boswell’s executive level experience in beauty, personal care, and home care complement Bath & Body’s product focus and business model. Boswell’s experience in deodorant, skin cleansing and care, and hair care should prove particularly relevant, and will serve the firm well as it leverages its fragrance and bath leadership across expansion categories and products.

We believe Bath & Body Works has carved out a solid competitive edge in the sizable addressable markets it operates in. The company’s strong brand intangible asset is supported by its leadership position across the bath and shower and candle air freshener industries in recent years, which has been bolstered by BBW’s quick response to consumer trends. Quantitatively, the narrow moat is reinforced by a 60% average return on invested capital excluding goodwill that we expect the business to generate over the next decade, well ahead of our 8% weighted average cost of capital estimate.

We believe Bath & Body Works has carved out a solid competitive edge in the sizable addressable markets it operates in. The company’s strong brand intangible asset is supported by its leadership position across the bath and shower and candle air freshener industries in recent years, which has been bolstered by BBW’s quick response to consumer trends. Quantitatively, the narrow moat is reinforced by a 60% average return on invested capital excluding goodwill that we expect the business to generate over the next decade, well ahead of our 8% weighted average cost of capital estimate.

We don’t expect any change to our $80 fair value estimate for narrow-moat Bath & Body Works after analyzing second-quarter results, which weren't as dire as the firm's July announcement. Transaction count and average dollar sales fell as consumers ratcheted back discretionary spend to counter widespread inflationary pressures. However, the 5% drop in net sales to $1.62 billion leaves BBW on track to hit our full-year sales forecast of $7.2 billion (8% decrease). While gross margins stumbled 7.8% to 40.8%, we expect the figure to level off around 42% for the year, as the firm extracts inefficiencies and implements tactical pricing backed by innovation. Despite the degradation in sales and gross margins, the metrics continue to exceed prepandemic figures by 45% and 30 basis points, respectively, suggestive of the firm's competitive prowess.