Two Reasons Why Victoria's Secret Could Struggle to Sustain Margins

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Limited Brands ( LTD ), a specialty apparel retailer focused on lingerie, beauty and personal care products, competes with retailers like Abercrombie & Fitch ( ANF ), American Eagle ( AEO ), AnnTaylor ( ANN ), Gap ( GPS ), and J.Crew Group (JCG). Some of its popular brands include Victoria's Secret, in the lingerie business, and Bath & Body Works, in the personal care segment.

In its recent earnings release on February 24, Limited Brands reported strong growth in revenues which increased to $9.6 billion in 2010, up 11% over the same period last year. The firm also witnessed significant improvement in operating margin, which increased by 3.5% in 2010.

Based on the recent results, we have updated our price estimate for Limited Brands' stock to $33.36. We estimate that the Victoria's Secret brand is the largest value driver for Limited Brands, contributing about 54% to company's stock value. Bath & Body Works generates an incremental 31% to our price estimate.

See our full analysis and $33.36 price estimate for Limited Brands

Strong Margin Improvement at Victoria's Secret Stores in the U.S.

The EBITDA margin for Victoria's Secret stores in the U.S. increased by an estimated 3.5% in 2010 over the same period last year, as gross margin for the firm improved by 2.7% due to an increase in the merchandise margin rate as well as buying and occupancy expense leverage. SG&A also saw improvement, further pushing EBITDA margins up at Victoria's Secret stores.

We currently forecast Victoria's Secret stores' EBITDA margin to remain constant going forward as the company continues to reap benefits from its cost cutting measures undertaken during the recession. However, a decrease of even 1% in Victoria's Secret stores' EBITDA margin going forward would imply a downside of 3-4% to our $33.36 price estimate for Limited Brands' stock .

Below are two factors we believe could hurt Victoria's Secret's margins going forward:

1. Increasing competition in the U.S. intimate apparel market

Victoria's Secret's U.S. stores could face increasing competition as new players and established brands enter the intimate apparel market. This can lead to an increase in marketing expense as Victoria's Secret tries to defend its market share. Also, heightened competition may lead to more competitive pricing initiatives and could negatively impact Victoria's Secret U.S. EBITDA margin in the future.

2. Expanding reach to wider range of consumers

In an attempt to reach a wider range of consumers, Victoria's Secret has launched lower priced collections. The inclusion of lower priced items in Victoria's Secret's product mix will likely lead to lower overall profit margins through reduced per-item top line revenue.

Drag the trend line in the modifiable chart above to see how various EBITDA margin scenarios for Victoria's Secret's U.S. stores could affect Limited Brands' stock value.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: AEO , ANF , ANN , GPS , LTD

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