Consumer Uncertainty Tempers Near-Term Profits at Bath & Body Works

We plan to lower our $82 fair value estimate for narrow-moat Bath & Body Works BBWI 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.

Despite current challenges, we still view the shares as attractive, as we believe cost inflation and consumer apprehension will normalize over time, allowing BBW to return to its long-term profit algorithm. BBW stood firm on a 20% operating margin goal, and it is testing pricing mechanisms on products and pursuing a $200 million cost-saving plan that should help steer the business back to historical profit levels. However, we now contend that this goal is unlikely to be reached until around 2025, with BBW calling for 2023 sales that are flat to down by a mid-single-digit rate with a 16% operating margin, bound by a fragile consumer and cost inflation that is unlikely to abate for a few more months. This is lower than our preprint 2023 projection, which included 4.5% sales growth and a 19.6% operating margin; our pending reduction in our 2023 sales and profit forecast is the main driver of our updated fair value estimate.