Hedge fund Barington Capital is urging L Brands (LB) to separate its Bath & Body Works unit from Victoria's Secret in order to improve long-term value for shareholders.
BARINGTON URGES VICTORIA'S SECRET, BATH & BODY WORKS SPLIT: Barington Capital sent a letter to Leslie Wexner, the chairman and chief executive officer of L Brands, urging the company to consider splitting its Bath & Body Works unit from the struggling Victoria's Secret chain. In its letter, Barington argued that "correcting past merchandising mistakes" is one way it can rejuvenate Victoria's Secret. The hedge fund also called for L Brands to replace directors to improve the independence and diversity "needed to effectively oversee and advise management."
Barington stated that L Brands has a "long and impressive history" under Wexner's leadership, but added that "Unfortunately, over the past three years the company has significantly underperformed its peers and the market as a whole. Barington believes this is primarily due to the disappointing financial performance of Victoria's Secret resulting from merchandising missteps and the failure to maintain a compelling brand image that resonates with today's consumers. Furthermore, Victoria's Secret's struggles have overshadowed the exceptional performance of Bath & Body Works, resulting in the market failing to value the segment appropriately." In the letter, Barington suggested that it believes L Brands can unlock "substantial" value for shareholders by spinning off Victoria's Secret or pursuing an IPO of Bath & Body Works, arguing that such a transaction would not only facilitate the market more appropriately valuing each segment, but would also enhance the financial performance of each business by helping to improve its strategic focus.
Additionally, Barington called on L Brands to replace directors, including those with tenures of longer than 30 years, with new independent directors. It said "We recommend that the Board seek to recruit new directors from outside of the Columbus, Ohio community, and focus its efforts on identifying candidates who can help improve gender and age diversity on the Board as well as add valuable experience in areas including merchandising, marketing and international business development." Barington also urged L Brands to separate the roles of chairman and CEO to "further improve corporate governance and operating execution."
"We strongly believe in the value potential of L Brands and are confident that changes can be made to create meaningful long-term value for shareholders," said James Mitarotonda, chairman and chief executive officer of Barington.
RECENT EARNINGS REPORT: Last week, L Brands reported fourth quarter adjusted earnings per share of $2.14 on revenue of $4.85B, against analysts' consensus of $2.07 and $4.88B, respectively. Comparable sales for the quarter fell 1%, with a 7% decline at Victoria's Secret and an increase of 8% at Bath & Body Works. The company said it expects first quarter EPS will be approximately breakeven, well below the 13c consensus, while fiscal 2019 EPS will be $2.20-$2.60, also below the $2.75 consensus. Comp sales for the first quarter are seen down in the low-single digits, while FY19 SSS are expected to be up in the low-single digits. On its earnings conference call, the company said "everything is on the table" for the Victoria's Secret brand. The company has pulled back on investing in new and remodeled Victoria's Secret stores and is speeding up its store closure plans from its previous average of roughly 15 store closures a year. The company plans to close about 53 Victoria's Secret stores this year, it said. "There are no constraints. We are not financially constrained, and we've got a lot of different things that we have and can consider," the company commented.
Following the earnings report, Bernstein analyst Jamie Merriman downgraded L Brands to Market Perform, telling investors in a research note that her prior Outperform rating was based on a view that investors were paying for Bath & Body Works with a free option on Victoria's Secret. While that fundamentally hasn't changed, and her DCF still suggests significant upside to the stock if management is able to stabilize Victoria's Secret, Merriman said she now believes stabilization for Victoria's Secret is "unlikely" in 2019 and struggles to see any catalysts that will unlock a higher valuation. Barclays analyst Chethan Mallela, meanwhile, upgraded L Brands to Overweight, saying he sees the initial FY19 outlook as "prudently" cautious and "potentially conservative," but acknowledged that he sees an "emerging strategy" for Victoria's Secret that could build visibility to an eventual brand recovery as well as an "undemanding valuation." MKM Partners analyst Roxanne Meyer contended that while Bath & Body Works "continued to shine," L Brands' Victoria's Secret and PINK brands remained pressured. Meyer expects little change in those trends until late in 2019, with limited visibility on how much impact changes in product, branding and marketing can produce. Jefferies analyst Randal Konik said Q4 capped "another year of difficulty" for L Brands and that the company's "path ahead is still challenged. Victoria's Secret market share is "eroding daily," the PINK brand "was a fad and could now see sales cut in half," and Bath & Body Works sales and margins have peaked, he said.
WHAT'S NOTABLE: A breakup of L Brands would follow a similar move by Gap (GPS) last week, which said it would separate Old Navy into a standalone company. Gap said plans to split into two independent companies, with one comprised of the Old Navy brand and the other a yet-to-be-named company, which will consist of the Gap brand, Athleta, Banana Republic, Intermix and Hill City. Following a review by Gap's board of directors, "it's clear that Old Navy's business model and customers have increasingly diverged from our specialty brands over time, and each company now requires a different strategy to thrive moving forward," Robert Fisher, Gap's chairman, said in a statement.
PRICE ACTION: In morning trading, shares of L Brands are up nearly 4% to $27.85.
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