Brett_Hondow
Summary
My previous rating was a buy (Dec 2023) as Bath & Body Works (NYSE:BBWI) continued to show very strong execution, as evident in the 3Q23 performance, which I expected to continue into CY24. I am revising my rating from buy to hold as I am worried about BBWI’s ability to meet FY24 guidance. Now that the stock is trading at 14x earnings, the expectation embedded is very different from a few months ago. If BBWI were to miss guidance, I am afraid that the market will punish the stock’s valuation by derating it downward.
Financials / Valuation
In 4Q23 (2024 Feb 29), overall sales grew by 0.8% to $2.91 billion, coming in above the consensus of $2.84 billion. Sales were driven by 4% growth in U.S. and Canadian store sales, but were offset by a 1% decline in international and 8% in e-commerce. Gross margin beat estimates by 116 bps, coming in at 45.9%, and despite an increase in opex of 130 bps vs. last year, EBIT saw $696 million (EBIT margin of 23.9%), which was above the consensus estimate of $641 million and a 22.6% margin. This led to a beat in EPS as well, coming in at $2.06 vs. $1.88. The key takeaway was that BBWI was able to show very positive beat in profitability despite minimal growth. With FY23 ended, management guided a FY24 net sales growth range between -3% and flat, which is below consensus expectations and way below what I expected for FY25 (5% growth). The EPS guide was rather discouraging compared to what I expected, as it implies ~$734 million of earnings vs. my expectation of $929 million.
Based on author’s own math
As I discuss below, I have concerns about BBWI’s ability to meet FY24 guidance if industry demand continues to moderate. In the model above, I expect BBWI to see revenue decline of 1.5% in FY24 (midpoint of management guide) and margin to stay flat at 10% (also management guide), leading to a revenue of $7.32 billion and $734 million in earnings. The stock valuation has also gone up to 14x, which means a lot of expectations are embedded in the stock compared to six months ago. So, even if BBWI were to meet its FY24 guidance, the upside is not attractive at all (just 4%).
Comments
With BBWI reporting a strong 4Q23 performance that led to the share price increase to ~$48 (up 10+% from my previous coverage price of $43.72), demand showing signs of weakness, management guiding to rather disappointing FY24 results, and valuation trading at 14x forward earnings (above average), I am now shifting my stance from a buy to a hold.
Particularly on my point on signs of weakness, it worries me a lot because a big part of my bullish view is that demand will recover. However, 4Q23 performance showed signs of demand softness that I am not really positive about. If we look at how each category trended in 4Q23 and the outlook, it paints a rather mixed profile vs. a positive one that I am expecting. Looking at 4Q23, while body care was up low-single-digits [LSD] percentage, driven partially by men’s (this is BBWI fastest-growing body care category, so it is natural for it to be up). However, home fragrance was down LSD, and the BBWI largest product category—candles—and sanitizers continued to see moderation in growth. The good thing is that BBWI managed to hold on to its market share in both of these categories, but I am concerned that further declines at the industry level will drag down the performance of BBWI. The weak demand environment did not seem to have any strong recovery in 1CQ24 either, as it was noted that BBWI saw pressured traffic coming into February, noting that its initial floor set did not perform as well as expected. Management also commented that volume will continue to normalize ahead and only see improvement in between 3/4CQ24. This basically means that in the near term, headwinds will persist in their largest category.
A big part of BBWI’s ability to drive margin outperformance is because of AUR growth, which grew 2% in 4Q23, mostly driven by FY23 price increases. The AUR expansion drove merchandise margin expansion by 290 basis points vs. 4Q22. I appreciate this margin improvement, but I am afraid this pricing strength is unlikely to happen in CY24 given the industry demand level that is moderating. This is quite a bad situation for BBWI because:
- If they raise prices, margins go up, but they risk losing share because consumers are likely to switch to cheaper products on the shelf (note that BBWI products are not the cheapest; there are plenty of other options at a cheaper price).
- If they don’t raise prices, they will start to face a tough competition compared to last year, and the lack of margin expansion combined with weakening demand could really hurt stock sentiment. Remember that the BBWI share price has gone from $27 to $48 in less than 6 months? A lot of optimism is embedded in the share price today.
I believe option 2 is more likely to happen, and we can tell from management comments that they are facing a “limit” organic price increase. As noted, they have “price-conscious consumers” and expect to see modest AUR expansion in FY24 with flat AUR growth in 1Q24.
We do have a very price conscious consumer. And so we are just ensuring that we are meeting them where they are at while using our very agile operating model where we’re constantly testing on the side for the best options. Source: 4Q23 earnings
Also, if we look at the guidance, a lot of it is weighed on 2CH24 performance, which carries a lot of risk in terms of expectations. For 1Q24, BBWI is guiding to net sales of -4.5% to -2.0%, which is a very poor performance (at the low end, it implies 40 bps more decline than FY23). To hit FY24 guidance, BBWI basically needs to see sequential improvement through the quarters or a big surge in 2CH24. My take is that, yes, this might be possible as management is going to focus on newer categories (note that these are new categories, so it is hard to be confident in the growth outlook), but I think it is better to see the entire industry demand trend for 2Q24 before determining whether the FY24 guide is possible to achieve and what are the expectations for 2H24. Because if 2Q24 demand continues to trend poorly with no signs of recovery by July, it will set a very bad tone for 3Q24, and investors are likely to assume a poor 3Q24, which implies heavy expectations for 4Q24 to really perform in order to meet the FY24 guide. I am not willing to take this risk of BBWI missing the mounting expectations when this happens. If we look at the forward PE range that BBWI has traded at, it is now near the high end of the range (at 14x today vs. the typical range of 8.5x to 16.5x). I could totally imagine BBWI missing the FY24 guide, leading to a major de-rating to 8.5x, which is near 50% downside. BBWI went from $27 to $48 in 6 months, which means it could also flip downwards back to mid-$20s in 6 months if my concerns play out.
The way I would monitor industry demand forward is by keeping track of management comments (specifically details regarding store traffic) and also how management is pricing its products. On the latter, if BBWI is able to continue sustaining its current price and see traffic improve, this might be telling that demand is recovering or is still healthy as current price level is not structurally hurting traffic.
Conclusion
I am recommending a hold rating for BBWI. While 4Q23 results were good, signs of softening demand raise concerns about BBWI ability to meet FY24 guidance. Management comments regarding poor traffic in February signaled that demand environment remains weak in 1Q24, and possibly 2Q24. Most importantly, the current 14x forward PE reflects high expectations, leaving limited upside potential. Hence, I think the move here is to wait and to see how industry demand trends in 1H24 before reassessing the outlook.
