L Brands (LB) Strategic Efforts Bode Well: Should You Hold?

L Brands, Inc. (NYSE:LB) has been riding high on strategic initiatives and positive earnings surprise history. The company’s shares have gained 7.3% in the past three months, outperforming the Zacks categorized Retail-Apparel/Shoe industry’s decrease of 10.1%. However, declining gross margin, higher operating and interest expenses dismal top-line performance for the third straight quarter remain primary hindrances for the stock at the moment.

Hidden Catalyst

We believe that L Brands’ sustained focus on cost containment, inventory management, merchandise, and speed-to-market initiatives has kept it afloat in a competitive environment. This is evident from its positive earnings surprise history. In the trailing seven quarters, it has outperformed the Zacks Consensus Estimate by an average of 8.6%.

L Brands continues to revamp business by improving store experience, localizing assortments and enhancing direct business. We believe these measures facilitate it to generate incremental sales and increase store transactions through higher conversion rate.

Following better-than-expected bottom-line, the company raised fiscal 2017 guidance. Management now projects earnings in the band of $3.10–$3.40 per share for fiscal 2017, up from the previous guidance of $3.05–$3.35. We believe that the company’s operational efficiencies, together with its new and innovative collections, provided a boost to the sales. Further, the company’s foray into international markets is likely to provide long-term growth opportunities and generate increased sales volumes.

Hurdles to Cross

Foreign currency headwinds along with higher operating and interest expenses might hurt its upcoming results. Further, it now foresees short-term challenges due its decision to exit the swimwear category, which according to analysts have failed to generate desired results. For the first quarter of fiscal 2017, the exit of the swim and apparel categories had an adverse impact of 6% and 9%, respectively to total company comps and Victoria’s Secret comps. In fiscal 2016, the same had a negative impact of 6% and 9% to total company and Victoria’s Secret comparable sales, respectively.

L Brands now anticipates comparable sales (excluding Victoria's Secret swim and apparel) in the second quarter to decline in the mid-single digit range.

Further, management anticipates gross margin to deteriorate year over year during the second quarter as well as fiscal 2017. In the first quarter of fiscal 2017, adjusted gross profit dropped 14% to $902.9 million, while gross margin contracted 320 basis points (bps) to 37.1% primarily due to buying and occupancy expenditure deleverage during the quarter. We noted that gross margin have contracted 230 bps, 190 bps, 180 bps and 170 bps in the fourth, third, second, and first quarters of fiscal 2016 to 43.3%, 39.7%, 38.5% and 40.3%, respectively.

L Brands currently carries a Zacks Rank #3 (Hold).

Stocks to Consider

Better-ranked stocks worth considering in the retail space include Aaron's, Inc. (NYSE:AAN) , Best Buy Co., Inc. (NYSE:BBY) and The Children's Place, Inc. (NASDAQ:PLCE) . All these three stocks sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Aaron's has reported better-than-expected earnings in the trailing four quarters, with an average beat of 10.6%.

Best Buy has an impressive long-term earnings growth rate of 11.8% and has also surpassed the Zacks Consensus Estimate in the trailing four quarters, with an average earnings beat of 33.8%.

The Children's Place has reported earnings beat in the trailing four quarters, with an average of 36.6%.

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