Victoria’s Secret (NYSE:VSCO) sells lingerie and other products for women. The company’s financial performance has been quite poor in recent years as the brand’s prestige seems to have decreased in customers’ eyes. Victoria’s Secret also holds a significant amount of debt, leveraging investors’ risks. The company is trying to make a turnaround through a better branding strategy, and I believe that at the current price a turnaround would signify a very fruitful investment case. If the poor performance continues, though, Victoria’s Secret’s share price fall is likely to continue.
The Company & Stock
Victoria’s Secret sells intimate apparel for women in the United States as well as internationally. The company also sells products such as fragrances, swimwear, body care products such as skin care and hair care products, sleepwear, and accessories such as shoes, keychains and wallets. In the United States, bras represent 33% of Victoria’s Secret’s revenues, with panties having a share of 22% and beauty a share of 16%. In addition to United States, a meaningful portion of revenues come outside of the US, including airports, operations in China and the UK, and franchising.
I believe that Victoria’s Secret’s brand value has seen a decline in recent years, being the driver behind the company’s declining sales. The company is focusing on revitalising its brand through a better analysis of the company’s current and potential target customers, and through a more effective marketing strategy in social media channels. The company urgently needs an improved brand image to turn around the sales trend. A turnaround in the effectiveness of the changes is yet to be seen – Victoria’s Secret’s financials have been very poor in recent quarters.
Since the company’s IPO in 2021, Victoria’s Secret’s stock has lost most of its value with a mostly consistent fall in price:
Victoria’s Secret’s revenue trajectory has been quite poor – from FY2019 to trailing figures, Victoria’s Secret’s revenues have fallen by around 24% in total. The company was hit especially hard in FY2021 because of the pandemic, affecting sales in especially airports. Excluding the pandemic effects, Victoria’s Secret’s revenues have fallen quite consistently.
Along with revenues, Victoria’s Secret’s EBIT margin has been inconsistent. The company has mostly achieved single-digit EBIT margins with an average of 6.4% from FY2019 to FY2023. Currently, the company’s trailing EBIT margin stands at 6.7%:
The company has a leveraged balance sheet. Currently, the company has long-term debts totalling almost $1.3 billion – compared to Victoria’s Secret’s market capitalization of $1.5 billion at the time of writing, the amount seems quite excessive. I believe that the debt is a double-edged sword for current investors – if Victoria’s Secret’s financials improve, the debt works as a leverage in investors’ upside. On the other hand, further declines in revenues could prove detrimental to the company in the long term because of the debt.
Victoria’s Secret seems cheap on a forward P/E basis – currently the stock trades at a forward ratio of 8.6. Still, the ratio is above Victoria’s Secret’s historical average of 7.5:
The low P/E multiple reflects Victoria’s Secret’s poor financial performance. I believe that if the company can do a turnaround in its brand image, the stock could prove to be worth way more than currently. On the other hand, if the decreasing revenues continue in their trajectory, the stock could be worth way less than it currently is. To demonstrate the valuation, I constructed two discounted cash flow model scenarios for Victoria’s Secret, one depicting a bullish scenario and the other a bearing one.
In the bullish scenario, I model in a fair amount of growth after FY2024 – after revenue decreases of -2.5% in FY2024, I estimate the growth to jump into 7% in FY2025 and 8% in FY2026 as the brand strategy yields results in the scenario. The growth slows down after FY2026 into a perpetual growth rate of 2.5%. In total, the estimates represent a CAGR of 5.2% from FY2024 to FY2033. For the company’s margins, I estimate some scaling after the current fiscal year into an eventual level of 8.0%, which I see as a reasonable estimate for the company. The mentioned estimates along with a cost of capital of 11.21% craft the following DCF model with a fair value estimate of $44.24, around 126% above the price at the time of writing:
On the other hand, if the current poor level of operations continues, Victoria’s Secret’s stock could be a very poor investment. In the bearish scenario model, I estimate the company’s revenue decreases to continue in the following years with a FY2025 revenue decrease of -5%. In the model, I still estimate the operations to finally stabilize into stable revenues of around $5 billion with a 0% growth in FY2032 after years of a slow decline. For the margins, I estimate a decline as the company’s scale decreases – after a slight improvement in FY2025 as a result of a stronger macroeconomic state than in FY2024, I estimate the margin to a fall into a level of 5.0% where the margin stabilizes. In this scenario, the fair value estimate is $7.89 with an implied downside of 60% into the stock price at the time of writing:
At the moment, markets seem to price in a 32% probability for the bullish scenario and a 68% probability for the bearish one, when simplified to two possible outcomes. I believe that this association is quite fair considering the current performance – the valuation seems mostly fair, although it is very volatile and challenging to assess.
The used weighed average cost of capital is derived from a capital asset pricing model:
In Q2, Victoria’s Secret had $24 million in interest expenses. With the company’s current amount of interest-bearing debt, the company’s interest rate comes up to a figure of 7.54%. Victoria’s Secret seems to leverage debt quite aggressively – I estimate a very high long-term debt-to-equity ratio of 50%.
The risk-free rate on the cost of equity side is the United States’ 10-year bond yield of 4.65%, as I believe that the rate represents a fair assumption of a riskless return. The equity risk premium of 5.91% is Professor Aswath Damodaran’s latest estimate for the United States, made in July. Yahoo Finance estimates Victoria’s Secret’s beta at a figure of 2.00. I believe that the high beta is a result of the highly leveraged balance sheet. Finally, I add a small liquidity premium of 0.3%, crafting a cost of equity of 16.77% and a WACC of 11.21%, used in the DCF model.
The investment case for Victoria’s Secret is very volatile. The stock’s investment case relies on a turnaround in Victoria’s Secret’s brand image, as the sales decreases in recent years have investors worried about the company’s future. Victoria’s Secret also holds a very significant amount of debt, making the investment case even more volatile. At the moment, I believe that the stock’s price quite correctly assesses the probabilities for financial outcomes, as demonstrated by the DCF models. For the time being, I have a hold rating for the stock.