Victoria’s Secret: It Might Just Be a Value Trap (NYSE: VSCO )

victoria’s secret (NYSE: VSCO) as a specialty retailer of lingerie and other apparel and beauty products worldwide.

The company’s stock has gotten attention for the wrong reasons over the past few months dormitory. The company has lost about 50% of its value so far this year, while the broader market has gained nearly 18%.

In today’s article, discussing the latest earnings results, we’ll look at recent macroeconomic developments to gauge how they impacted VSCO’s financial performance for the current quarter and how that might impact in the near future.

second quarter earnings

Many retailers and companies in the consumer discretionary sector have performed relatively poorly over the past quarter, and this is reflected in their share price movements.most of them In recent months, attention has been focused on the health of U.S. consumers and their spending behavior, but also on the future. Among them, Macy’s (Medium)Already sent Prudent guidanceleading to a general sell-off in the industry.

Victoria’s Secret is no exception, having underperformed lately. In the most recent quarter, VSCO posted a net loss of $1 million, compared with a net profit of $70 million in the second quarter of 2022. Operating performance also deteriorated significantly, with operating income falling to $26 million from $98 million in the second quarter of 2022. last year. Not only has net profit been hit hard, but revenue has also been hit hard, with net sales falling from $1.521 billion in the second quarter of 2022 to $1.427 billion in the second quarter of 2023, a year-on-year decrease of 6%.

In our view, these results can largely be explained by some key macroeconomic indicators, such as the level of consumer confidence in the US.

Consumer confidence is often viewed as a leading economic indicator that helps analysts and investors gauge how consumers’ spending behavior may change in the near future. The chart below shows US consumer sentiment over the past 12 months.

We can clearly see that confidence levels remained low in Q1 and Q2. This may indicate that consumers are more reluctant to spend more on discretionary, discretionary and durable goods as they feel less certain about their financial future and the health of the overall economy. In fact, it showed up in many retailers’ second-quarter results, including Macy’s, Foot Locker and even Victoria’s Secret. Revenue results for many retailers point to relatively weak demand for their products. Meanwhile, inventory management issues, deep discounting and inflationary pressures have put downward pressure on their margins and margins.

As consumer confidence started to improve significantly in the third quarter, we believe this will have a positive impact on the company’s financial performance starting later this year or early next year. Since it is a leading indicator, its signal may be delayed. The improvement in consumer confidence now means that there may be positive changes in consumer behavior in the coming months or quarters.

Looking ahead, there are two more important metrics to watch: inventory levels and accounts receivable.

stock

Inventory management has been a focus for many retailers over the past few quarters. VSCO’s stockpiles have also increased substantially in 2021 and 2022, but have already begun to decline. Going forward, we would like to see this trend continue, but we must note that this may only be achieved through deep discounting, resulting in continued margin compression.

accounts receivable

Accounts receivable is an important item to check when we want to ensure that sales figures are not artificially inflated. If accounts receivable are growing faster than sales, it may indicate that the company is selling more credit or has changed its revenue recognition policy in order to “pull demand” from future periods. Fortunately, that’s not the case with VSCO. The recent drop in sales has also been accompanied by a drop in accounts receivable.

Going forward, it will be important to monitor whether this relationship continues.

capital allocation

Victoria’s Secret also announced a new share buyback program in January as part of its capital allocation. This has been done in two steps. During the first and second quarters, the company repurchased $125 million in stock. While the repurchases are relatively large compared to the company’s current market capitalization, these buybacks have not had a meaningful positive impact on the share price. Going forward, we do not expect another share repurchase program in the near term, as the company’s cash balance has been gradually declining and the financial performance does not appear to be sufficient to warrant another round of buybacks in the near term.

At the same time, the company’s total long-term debt is gradually increasing, which may cause some concern, especially in the current high interest rate environment. For this reason, one might question whether share buybacks are really the most efficient use of cash right now.

guide

Another reason for the sharp drop in stock prices is the relatively pessimistic outlook. The company expects its financials to deteriorate in the third quarter and for the full year.

The company expects net sales to decline in the low to mid-single digits in the third quarter of 2023 compared to net sales of $1.318 billion in the third quarter of last year. At this forecast level of sales, adjusted operating losses for the third quarter of 2023 are expected to be in the range of $45 million to $75 million. Adjusted net loss for the third quarter of 2023 is expected to be in the range of $0.70 to $1.00 per diluted share.

The deterioration could be due to expectations of continued weak demand, coupled with inflationary pressures and further rate hikes by the Federal Reserve.

Valuation

When looking at a set of traditional price multiples, we can see that VSCO appears to be trading at a substantial discount to the consumer discretionary industry median.

If we narrow down the peer group to the apparel retail industry, we can still see that VSCO’s valuation is relatively low compared to the rest of the industry.

But does that mean it’s a buy? In our opinion, no. A low P/E ratio doesn’t always mean great investment value. Sometimes they can just be a value trap. In this case, we think VSCO might actually be one of them. The company’s competition has increased significantly over the years, while its dominance has waned. We believe that the current macro and micro economic environment is too uncertain to accurately judge whether the company is likely to turn around in the short term.

in conclusion

Financial metrics gradually deteriorated, with both top-line and bottom-line results deteriorating.

An improvement in consumer confidence in the third quarter could have a positive impact on the company, but the uncertainty going forward is quite high. We don’t think VSCO has a moat or competitive advantage over its peers.

Valuations may be low based on traditional price multiples, but the company may just be a value trap.

For these reasons, we do not want to include VSCO in our portfolio and rate it a “sell”.