Description

I think BBWI represents a highly attractive risk-reward skew from currnet levels. Brown Mamba had a great, very detailed write-up in January of 2022 and so would direct you there for initial detail of the business and history. I wanted to write it up again with some additional points / update to restart the discussion as I think it has become a very interesting battleground/setup from here.

Over the last year and a half, BBWI’s stock has fallen from peak to trough about 50%. The stock has gone through a perfect storm, lacking a CEO / IR Team (and now CFO), lacking a long-term investor base as a result of the L Brands spin of VSCO, and optically being a COVID over-earner with high leverage (where bears think they have to give back more on pricing and don't believe this can return to positive comps for at least another 2 years). I think with the stock trading at ~$36 and ~12x NTM Street EPS the stock is trading like a bad business or an “okay” business at best, when in reality I think it is one of the few great retail assets that has a highly loyal customer base, significant runway in their current TAM, and significant cost cushion to maintain best-in-class margins even in a slower macro environment as inflation headwinds subside. With earnings finally ready to inflect back to growth in 2023 (albeit small), the business can be a significant compounder from there with line of sight to over $6.00 in earnings power by 2026, which represents a 30%+ base case IRR from the current share price assuming very minimal upside to the multiple as the market comes to our view.

• Why does this opportunity exist? The events of 2022 (CEO stepping down, multiple guide downs, significant margin pressures, broader consumer weakness) have caused many once bullish investors to “throw in the towel” creating an attractive situation to own a high-quality business with a proven and consistent business model that has shown the ability to grow through tough economic cycles in a category characterized by high replenishment and enthusiastic customer base. Many believe this business is now "broken" and will not return to positive top-line growth for the next few years.
• Best-In-Class Customer Loyalty: Fanatical customer base makes BBWI top-line more resilient in tougher economic conditions and the roll-out of their loyalty program in September should drive significant revenue uplift over the coming years and allow the company to manage their 60M customer file more efficiently than it has in the past (est. 5% additional revenue growth for every 15% increase in customer penetration, as compared to a MSD/HSD steady state top-line algorithm), creating an additional call option on revenue and margins. While we may not see the true impact in numbers until the 2H of 23 as the company works to separate their tech stack from VSCO, I think you want to own this stock ahead of that as it is another call option on the business being able to return to its historical algo, which is all I think you really need for the stock to work.
• Numerous Levers to Drive Top-Line Growth: BBWI has numerous levers to drive additional growth and market share gains over its 3–5-year plan including new product expansion (hair/skincare), digital shift/movement to off-mall locations, new customer acquisition / existing customer retention, loyalty adoption / product auto replenishment programs, and pricing / more creative and data-driven promotions.
• Temporary Margin Headwinds Should Begin to Abate in 2023: BBWI is faced nearly 500bps of temporary macro/idiosyncratic margin headwinds in 2022, many of which are likely to begin to abate in 2023 – the Street is only implying about 130bps in margin recovery in 2023. Cushion should allow the business to drive mid $3s at minimum of earnings power in 2023 (vs. Street of $3 and guide of low of $2.50), creating a near term “floor” on earnings even in a worse macro picture.
• New CEO Hire Removes Overhang and Helps Lead BBWI Into Next Stage of Growth: Gina Boswell provides needed sales, marketing, and product strategy experience to bring BBWI into next stage of growth coming out of COVID and removes lingering overhang that has existed throughout 2022. Checks on her have been mixed, but there are clearly signs of her working to build out the team she needs to execute her strategy and expect a new, high quality CFO to come on board soon over the next few months.
• Attractive Valuation: At 12x NTM Street EPS (or 8x my CY24 numbers), the company currently trades like a low margin, mall-based apparel retailer (discount to URBN, AEO, who have topline growth/margins less than half of BBWI’s) vs. higher quality consumer compounders and one of the better comps in ULTA at 20x+ Street earnings. Applying a 15x exit multiple to my FY24 earnings forecast implies a 60% 1 year IRR. On a 3 year basis I believe the IRR can be closer to 30%+. A “home-run” scenario – where you exit at 18x, closer to ULTA, implies a nearly 50% IRR from today’s close. I think downside here is limited with trough earnings around $3.00 for this year - I think the business would at minimum get 10x on that number implying about 20% downside, or a 3:1+ upside downside skew.

HIGH LEVEL OUTLINE OF BULL AND BEAR THESIS - laying out the overall points for discussion purposes

Bull

• Good business trading like a bad business – BBWI is one of the few great retail assets and not fashion / fad driven
• Strong moat and customer loyalty
• Staple-like category that should be more resilient in a recession
• Low Valuation Unjustified – pricing in a near worst case scenario and there is no existential threat / bear thesis
  • Current P/E is what you usually see for companies with balance sheet or terminal value issues
  • There is absolute valuation support
• Numbers sufficiently reset to grow off of into 2023/24
  • Numbers completely sanbagged for this year which should drive posiitve estimate revisions throughout the year
  • Strong sustainable pricing power / unit growth - market currently mistinterpreting marketing/promo events as a negative when this is standard pricing architecture for the company
  • Margins are manageable even if inflation lingers for longer as a result of 500bps+ of raw material inflation that BBWI has seen which they should be able to get back this year - they have been hit the worst of almost any consumer company I can think of
  • In a steady state generates significant cash for capital returns
• Long runway in current TAM – core business can continue to comp well, large new category opportunities and international business should continue to compound
  • COVID benefits already lapped and gifting will recover more quickly (50% of sales)
• Operating near “peak fear” in consumer discretionary – no LO’s want to own retail and while holder list is scary think investor base becomes more solidified over time
• New CEO Gina Boswell is not proven yet, but she is in the process of building out a brand new C-Suite to take company into next phase of growth - I expect Third Point's activist involvement likely leads to a good new CFO hire in the near term which potentially gets people excited

Bear

• Stock has faced perfect storm this year and the headwinds are not over with data continuing to show signs of deterioration - why should this business return back to its historical algo when it was all driven by mangement execution back then? They are all gone.
• Have taken 19pts of price since pre-COVID vs. 3pts per year historically - why shouldn't they have to give this back this year? 
• Crowded HF holder base with no LO support
• Undesirable factor exposure in consumer and relatively poor liquidity
• Trade down dynamics in a recession would negatively impact customer churn and pricing, given BBWI is priced higher than other alternatives - this is not a recession resistant category
• No reason to own until macro uncertainty goes away

Catalyst

- Numbers beats / return to algo

- New, high quality CFO hire

- Loyalty program uplift