With The Victoria’s Secrets Deal Looking Very Uncertain, L Brands’ Stock Could Plunge To $5


L Brands (NYSE: LB) stock is down almost 40% since the beginning of this year to the current price of around $11 per share, as the spread of the novel Coronavirus rattles the stock markets and the broader economy. L Brands has underperformed the S&P thus far through the crisis, as the company’s sales have taken a hit due to the closures of stores since the month of March. The company’s first-quarter has been wiped out due to the outbreak of coronavirus, which has forced people to stay indoors, resulting in a steep decline in the demand for the company’s products. To make matters worse, Sycamore Partners has decided to terminate the agreement to buy a 55% interest in Victoria’s Secret. Taking into account L Brands’ falling revenues, rising debt, and shrinking margins, we estimate that L Brands’ stock price could slide to levels of around $5 if the deal is called off. Our interactive dashboard How Low Can L Brands Stock Go? discusses one possible set of expectations for the company as a downside scenario for the company’s stock.

 

What Factors Could Lead To A Decline In L Brands’ Stock?

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#1. L Brands’ Total Revenues could decline by 25% to $9.7 billion in FY’20

  • L Brands’ revenues could fall by about 25% in FY’21, on account of weaker demand, rising unemployment, lower income-per-capita income, and potential supply constraints.
  • The outbreak of COVID-19 has had a major impact on economic activity, and this has resulted in the people losing jobs or taking pay cuts, which is forcing them to delay/cut discretionary expenditures.
  • Notably, the company has temporarily shuttered its stores in the US and Canada, which is resulting in major revenue loss for the company.

 

#2. Depleting Cash Reserves And Ballooning Debt

  • At the end of FY’19 (ending January), L Brands’ total debt balance stood at $5.5 billion, with Debt to EBITDA ratio of nearly 6.5x. The company has also decided to draw down $950 million from its Revolving Credit Facility-further, increasing its debt balance.
  • On the other hand, the company held cash reserves of just around $1.5 billion-one-third of the company’s debt figure.
  • Moreover, the company’s cash balance has steadily declined over the year, falling from $2.5 billion in 2015 to around $1.5 billion in 2019

 

#3 Potential Termination Of The Deal

  • With ballooning debt and depleting cash reserves, the cash that the company was expected to receive from Sycamore Partners for the 55% stake in Victoria’s Secret could have provided a boost to the company’s financial position in the current situation.
  • Now with the deal hanging by a thread, the termination of the deal is likely to trigger a steep decline in the company’s stock. The investors will be watching the company’s cash situation closely when the company reports its Q1 results in late May.

 

Arriving at L Brands’ valuation:

  • L Brands stock could fall to levels of $5 if the P/S multiple declines to about 0.14x – not a stretch, given that it is already around 0.2x now – while revenue per share shrinks 25% from $47 over 2018-19 to $35 in 2020.
  • The likely trigger is going to be L Brands’ Q1 results when the company is expected to confirm the hit to its revenue. It is also likely to accompany a lower Q2 as-well-as full-year 2020 guidance.
  • Specifically, we believe the full-year revenue expectations formed by the market at the time of Q1 results may be closer to $9.7 billion – about 25% lower than the FY 2020 revenues. The market is going to lower its expectations, and the company’s P/S multiple is likely to shrink to around 0.14x – or even lower.

We do believe these trends are likely to reverse in later quarters of 2020, and as the Coronavirus crisis is tamed during late Q2, higher revenue and earnings expectations will replace the dire scenarios that are easily imagined during difficult times. That said, the actual recovery and its timing hinges on the broader containment of the coronavirus spread. Our dashboard forecasting US COVID-19 cases with cross-country comparisons analyzes expected recovery time-frames and possible spread of the virus

Further, our dashboard -28% Coronavirus crash vs. 4 Historic crashes builds a complete macro picture. Additionally, the complete set of coronavirus impact and timing analyses is available here.

But till the current crisis passes, there is a real threat of many companies in the apparel industry not being to raise enough capital or generate enough profits to remain a going concern. We answer the question, ‘Will Gap Survive The COVID-19 Crisis? in a separate interactive dashboard.

 

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