Gene Marcial's Stock Picks

Marcial: A Turnaround at Limited Brands?


Many retailers are still struggling with soft consumer spending, even as signs of an economic recovery emerge. But one specialty retailer, Limited Brands (LTD), which operates about 3,000 stores for women's apparel, lingerie, and personal care and beauty products, is displaying signs of a turnaround, note several analysts.

The stock raced to 14.75 on Sept. 1 from a 52-week low of 5.98 on Mar. 6, 2008. But it's still well below an all-time high of 32.60 in 2006 and a 52-week high of 22.16 on Sept. 8, 2008. "The [current] turnaround at Limited isn't yet being priced in," says Howard Tubi, retailing analyst at RBC Capital Markets, who rates the stock outperform.

The turnaround is showing up at Limited's two principal units, Victoria's Secret, which sells intimate apparel and accounts for 56% of Limited's sales, and Bath & Body Works, a specialty retailer of personal care and home fragrance products that makes up 26% of company sales. The two units' upbeat results helped boost Limited's better-than-forecast second-quarter results. Limited's other brands include Pink, La Senza, and Henri Bendel.

The turnaround story at Limited "continues to unfold as we would expect," says Tubin, with management remaining committed to introducing new products and supporting them with more marketing and media campaigns. At the same time Limited continues to be conservative in operating costs, inventories, and capital expenditures.

One strategy Limited has adopted at Victoria's Secret is to reduce prices on certain products to attract new customers and stimulate sales. Generally Wall Street frowns on price cutting because it could hurt profit margins. But some analysts like the moves made by Victoria's Secret. Tubi says reception of Victoria's price-cutting strategy has been good, as it offers value to existing customers and entices new ones to its stores.

Victoria's Secret turnaround key Because of the favorable customer response, Tubi says, management plans to lower prices of more products. For example, Victoria's Secret plans to offer a new basic bra and a line of Pink brand products at lower prices. Tubin says management has taken efforts to avoid any "negative margin implications" in the reduced pricing of some of its products.

Victoria Secret's strategy of offering products at reduced prices is "gaining traction," says analyst Michelle L. Clark at Morgan Stanley (MS) (which has done banking for Limited Brands). She rates the company's shares equal-weight (neutral), but nonetheless acknowledges "signs of improvement" at Victoria's Secret and Bath & Body Works. Clark notes that the turnaround at Victoria's Secret is significant because it represents 70% of Limited's operating profit. At Bath & Body Works there's also "continued momentum" on the upside, she says. Bath & Body Works' top three categories, including candles and home-fragrance products, which comprise 70% of the unit's sales, have shown improvement, she adds.

At the same time Clark thinks international markets are a big source of Limited's expansion. "We see an opportunity for Victoria's Secret to become a global brand over the next five years," she says . But for her to be positive on Limited shares, Clark says she needs "to gain increased comfort that signs of improvement at Bath & Body Works can continue" and that Victoria's Secret's strategy of lowering prices will continue to gain ground.

Analyst Thomas A. Filandro of Susquehanna Financial Group believes the improving trends at Limited will have legs. So he raised his earnings estimates for fiscal year 2011 (ending on Jan. 31) by 8¢ a share, to $1.06, reflecting "higher base sales and margin assumptions." For fiscal 2010 he forecasts earnings of 84¢, up from a prior estimate of 83¢. In fiscal 2009, Limited earned $1.05 a share.

most analysts still cautious Filandro said in a research note that Limited "has a firm handle on defensive levers in the business," including inventory management, budgeting, and controlled capital spending, providing greater earnings visibility. He has raised his 12-month stock price target to 17 from 15. (Susquehanna seeks to do business with Limited.)

Also bullish on Limited is analyst Kimberly Greenberger of Citigroup (C), who upgraded her rating to buy from hold in late August. She expects the company's overall sales to improve and margins to expand. The international markets, she adds, provide an opportunity for more growth. Greenberger raised her 12-month stock price target to 18 from 15.

Investors also get a hefty dividend yield of 4.2% with Limited shares. But Wall Street has yet to be convinced of the company's quiet turnaround, with only five of 20 analysts recommending buying the stock. Thirteen analysts rate Limited a hold, and one recommends selling the stock.

Yet Limited has recently attracted increased buying from some of its big shareholders. As of June 30, 2009, Janus Capital Management purchased 10.2 million shares, bringing its total holdings to 11.4 million shares, or a 3.5% stake. Another institutional holder, AXA, bought 4.7 million shares, boosting its stake to 27.6 million shares, or 8.6%. Barclays Global Management acquired 4.9 million shares, raising its stake to 15.4 million shares, or 4.8%.

The increased buying by these institutions shows faith in this specialty retailer even as consumers keep a strong hold on their wallets.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.
Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.

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