|Shares Out. (in M):||261||P/E||12.7||10.7|
|Market Cap (in $M):||15,634||P/FCF||0||0|
|Net Debt (in $M):||3,411||EBIT||1,980||2,169|
|TEV (in $M):||19,045||TEV/EBIT||9.8||8.8|
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Bath and Body Works (BBWI) today presents an opportunity to buy the market share leader in both its major categories with sales per square foot upwards of $900 and a history of MSD+% comps at just 13x Street Fwd EPS.
Although the company is currently overearning on margins, we believe the market is materially underestimating the quality of BBWI’s concept and their ability to continue to grow HSD % in the out years. With comparable beauty concepts trading at or above the market multiple (i.e., Ulta) of ~20x, we see the potential for upside on both an earnings and EPS multiple basis resulting in a 3.5x up/down skew over the next year. However, an investor does not need much multiple expansion to win. Our estimates call for a 25+% IRR over the next 4 years at a 15x Fwd EPS exit multiple. With the story much cleaner post-spin, focused management, and the potential for massive share repurchases we believe the business has runway to compound EPS in the high teens per year.
BBWI has shown an ability to take significant market share (or create their own demand) and continue to grow regardless of the industry environment.
Many of the COVID benefits they saw have already been lapped per data from other industry players, however, BBWI continues to show solid growth.
Strong customer quality and loyalty insulates BBWI from major industry headwinds and provides a baseline growth level as seen by their MSD% comp from 2010-2015 despite struggles acquiring new customers.
There are numerous levers to sustain a HSD% comp algorithm in the out years including:
Continued customer acquisition
New product expansion
Expansion of digital and shift to off-mall locations
Launch of loyalty and auto-replenishment programs
BBWI is the RemainCo from the recent L Brands Victoria Secret spin. It operates in three primary categories: Home Fragrance, Body Care, and Soaps and Sanitizers (~45%/40%/15% of revenue respectively). When it was a part of L Brands, Victoria's Secret was the primary focus of management and investors. However, BBWI was a diamond in the rough and sustained positive comps for 40 quarters in a row pre-COVID:
The most impressive part of this success remains the fact that this was done while the company was the secondary focus of L Brands, had a primarily mall-based footprint, and was not properly investing in e-commerce. In fact, they have a history of continued outperformance of mall traffic levels despite these headwinds.
Despite operating in a seemingly commoditized industry, BBWI has shown the ability to continue taking share and displays pricing power. The business also benefits from the replenishment nature of their products creating repeat customer interactions (4-6 weeks replenishment cycle) which drives their ~60% customer retention rate.
BBWI operates primarily in North America with an International segment that is still in the early stages (~4% of revenue). In the international segment, they operate through a partner-based model where they are paid on a royalty basis. Thus far partners seem pleased with the results and are looking to continue expanding.
This business is also vertically integrated and has built Beauty Park in concert with many of its key suppliers (source 60% of finished goods and 30% of components at this location). This enables what BBWI likes to call their “read and react” testing philosophy. Their reorder times tend to be around 3-5 weeks long allowing them to optimize for different customer trends almost immediately. The value of this was reflected during COVID when they were able to roll out spray sanitizer as a new product in March 2020 and rapidly increase production. They can test new products in small quantities and expand production if it is performing well or cut production with only a small inventory loss if it is performing poorly. This allows BBWI to launch 6,000 new SKU’s and 250 new fragrances annually. Additionally, the business tends to have strong merchandise margins upwards of 70% despite being highly promotional due to an optimized product line and consistent product packaging.
The business faces a reasonable degree of competition across its major categories. A rough sizing of each is as follows (via BBWI Investor Day):
Body Care: This segment is part of the Beauty and Personal Care market which is sized upwards of ~$71b (~3% market share).
Home Fragrance: This category primarily consists of candles and air fresheners and represents an ~$11b industry (~22% market share).
Soap and Sanitizers: ~$5b industry (~21% market share)
BBWI operates in the “masstige” space, which basically means they price in between the mass and prestige players. Across BBWI’s categories, it has shown the ability to continue to take share from both mass and prestige competition. At this point, mass is likely a bigger focus as prestige has been losing share across BBWI’s major industries. However, we do not believe mass presents a legitimate threat to BBWI for the time being. BBWI’s customer base tends to be less price-focused and is looking for quality at a reasonable price that BBWI provides them. The following from a former explains their advantages vs mass merchandisers well:
“Yes. I think people do place a higher value on the BBW candle versus the Target and Walmart candle. And they perceive that the BBW candle is of quality on the number of fronts, like, one is the burn time. So it seems to last longer. The second is the fragrance load. So it smells, like, it throws off a really, like, a strong fragrant that fills your home. But competitive candles don't always necessarily deliver. And then the third are the range of fragrances though there's a lot of choice, probably more than what's readily available at Target and Walmart. And then the fourth is just the design aspect because they're constantly innovating and what can we do to make this look as premium as possible? And the Target and Walmart always end up copying BBW, but they're [BBWI] really first to market with a new innovative candle design.” - Former Senior Brand Manager Body Care at Bath and Body Works
There is a similar difference in quality and consistency in the body care segment versus mass competition (albeit smaller). Although someone who does not actively purchase candles/body care may be skeptical of this, BBWI’s history of MSD+% comps and strong customer loyalty indicate a reflection of these advantages in the numbers.
The foundation of BBWI’s strength and history of MSD+% comp growth stems from its untouched customer loyalty. Despite selling what should be a commoditized product, BBWI has very strong retention rates and has consistently grown retained customers and spend per customer as seen below:
The key here is the core base of retained customers that have remained extremely loyal over the years and have been driving customer spend expansion. The years active lifetime spend table also speaks volumes to how a customer continues to grow with the brand over time. Doing some rough math with this data, we can calculate that these “retained customers” make up upwards of 85% of revenue historically and have a net dollar retention rate upwards of 100%.
This level of “customer love” remains unmatched within the industry. Morning Consult determined that BBWI was the 4th most loved brand by Women, behind Google, Netflix, and YouTube. This put them above brands like Target (#6), Nike (#11), Dove (#13), and Starbucks (#15). Additionally, many of their customers almost seem to treat buying products from BBWI as one of their primary hobbies. There are numerous blogs, Instagram pages, and YouTube channels dedicated to discussing new BBWI releases.
Instagram data (as of Jan 2nd) is reflective of this customer love as seen below:
The average likes metric is reflective of the true engagement of customers, not just those who follow and never look at the page again. Their engagement thwarts that of any other similar players, and they are growing their follower count at a respectable clip. The difference in follower count and average likes between BBWI and their largest direct competitor, Yankee Candle, is quite sizable.
When considering the long-term growth prospects of this business, this highly engaged and loyal customer base is paramount. These customers continue to purchase more units from BBWI and are willing to do so at higher prices each year, which drives a sustainable underlying algorithm. BBWI from 2010-2015 saw declines in their customer base, yet the ability to expand existing customer spend drove their consistent MSD+% comps.
There is no doubt that BBWI is a “COVID-winner”. However, the prevailing market sentiment appears to be that many of its gains are unsustainable. When thinking about how BBWI benefited on the top-line, it can be broken down into price and quantity. The price end remains a retail-wide factor driven by consumer wallet share shift towards goods, wallet share expansion, and supply chain issues driving inflation (CPI up 6.8% YoY in November). Whereas the quantity side is much more BBWI specific as seen by the outsized success of their soap and sanitizer business for example. However, when drilling down into these separate factors it is clear that much of the quantity-driven benefits have been lapped in 2021, and the impact of promotional increases is overstated on the pricing side (with respect to revenue).
Starting with the quantity side, the two key COVID-driven increases are as follows:
Soap and Sanitizer Demand Surge
Home Fragrance Demand Surge
Below, we attempt to touch on both factors and explain why these benefits are not as fleeting as the market perceives.
Soap and Sanitizer Demand Surge
S&S grew dramatically in 2020, and there is no denying that a lot of this growth was one-time. However, thus far in 2021, much of this growth has already been lapped and the company has seen negative growth rates in Q2 and Q3 in terms of S&S sales. Based on management commentary we can estimate the S&S numbers for Q2 and Q3 as seen below.
There has been a meaningful stabilization in S&S revenue as seen above. Although COVID cases have skyrocketed again as of late, it is important to recognize that Q2 and Q3 took place post-vaccination when things were starting to normalize. Additionally, with the way COVID is faring it looks like it will be a lingering aspect of our lives for the coming years even if it is much less of a focus. As a result, it does make sense that there should be a step function in the usage of these products longer term as people become more hygiene conscious. Trying to pinpoint where the industry will rebase remains a difficult task, but there has already been a significant give-back of hand sanitizer gains and BBWI is still performing very well.
Additionally, BBWI lost share in S&S in 2020 as much of the incremental demand flowed to the cheapest products available in mass locations (many temporary BBWI store closures through the end of Q1 and throughout Q2). Market share in liquid soap per Euromonitor over the last 9 years can be seen below:
The potential to regain some share as demand normalizes provides a marginal mitigant. Euromonitor industry growth rate projections for liquid soap are -3% from 2021-2025. We have already seen widespread declines in the industry in 2021. If the estimate is a rough idea of where the industry sits in 2025, a rebasing post-2021 does not seem unrealistic (although growth should decelerate from pre-COVID levels). Per MULO scanner data, hand soap sales were down 19.2% YoY in Q3 (July-October) indicating there has been an industry-wide decrease as expected. A -3% CAGR over 5 years implies a -14.1% cumulative decline. With data indicating YTD down -19.2%, the implication of that estimate is growth post-2021.
Home Fragrance Demand Surge
This remains one of the most important factors as Home Fragrance represents upwards of 40% of BBWI’s revenue. The two key products in this category are air fresheners and scented candles. Like S&S, it makes sense that this segment saw significant growth in 2020 driven by more time spent at home. Per Mintel data, the industry (scented candles and air fresheners) grew 20.5% in 2020.
A pull-back appears reasonable, and it is what we have seen since Q2 of 2021. Per MULO scanner data, household candle revenue was -8.0% in Q2 YoY and -15.3% in Q3 YoY. Additionally, Q4 trends continue to perform poorly at -18.5% from November 15th to December 15th. However, putting BBWI in the same category as these other players would be an oversight. BBWI really entered the candle industry in the late 2000s. Despite their late entrance, the company CAGR’d home fragrance revenue at 16.8% from 2008 to 2018. This significantly outperformed the industry which had been flat over that same time period (5% growth in 2018 and 2019 prior to COVID, however).
Creating a rough map of market share based on available data for the last couple of years, we can see that BBWI has consistently gained share in the industry.
2021 estimates are based on a 30% 2-year stack growth for BBWI in Q4 (expected company-wide 2-year stack), a straight-lining of Newell Brands YTD 2-year stack growth into Q4 (will likely be lower), and a straight-lining of scanner LTM YoY revenue growth into Q4 for MULO companies (will likely be significantly lower). Despite the approach taken which will overstate growth from MULO and Newell Brands, it is evident that BBWI is taking significant share this year. The market share number itself is heavily overstated (likely closer to ~20-25%) as the current tracking data we have does not represent the entire industry, but it is reflective of the rate at which BBWI is taking share.
Looking at this information, it is evident that BBWI is relatively uncorrelated with the rest of the industry. In a way, they are creating their own demand, which has allowed them to continue growing regardless of the industry environment.
Our view is only confirmed by the fact that BBWI did not actually grow customer count in 2020 during peak-COVID. Due to store closures, they saw a slight decline in customers during 2020.
They are currently seeing customer growth upwards of 15% on a rolling twelve-month basis despite overall industry struggles and price inflation (per BBWI Q3 2021 Call). This means that they are less exposed to the incremental customer who purchased during COVID but is not planning on becoming a recurring user (hence why retention rates on recently acquired customers is so strong). Recent commentary from the Q4 earnings update when the rest of the industry is struggling only corroborates this story:
“Holiday (November and December) sales were above expectations with strong customer response across all categories. Fragrant body care and home fragrance sales increased substantially compared to last year" – 1/6/2022 BBWI Q4 Earnings Update
Additionally, candles are a low-ticket replenishment purchase. Unlike many big-ticket durable items that similarly benefited during COVID, customers who want to use candles will have to continue to purchase post-COVID (cannot buy and use for years).
Although biased, the following from Newell Brands and BBWI management seems to confirm our view:
“But then as we think about the longer term, there's nothing about what we're seeing that I would say is a huge spike that will all go away for all the reasons we've discussed. Again, these are categories that were growing pre-COVID. I would expect that they would continue to grow post-COVID.” – 12/2/2020 L Brands (BBWI) at Morgan Stanley Global Consumer Conference
“Look, I think it's -- with this pandemic and in the second half, still being so uncertain, we really don't know how the complexion of the world and the categories will change…But there are some things I would say, look, there are some businesses, whether it's food, food containers, organization, some of these are going to stick. Candles are going to stick.” - 4/30/2021 Newell Brands Q1 2021 Call
“Although we expect the scented candle category to continue to moderate, results from a recent survey among scented candle users showed that use frequency remains high, with almost 33% of those surveyed aiming to use the product more often in the next 6 months.” 7/30/2021 Newell Brands Q2 2021 Call
Considering the industry-wide decline in recent months, Mintel has forecasted ~3% industry-wide growth for the next 5 years indicating they believe there has been a rebasing of sorts in 2021. There will be a tough comp in Q1 of 2022, but after that, comps should significantly ease up as many of the COVID-driven quantity increases have been dropped in the back half of 2021.
BBWI’s customer base as discussed earlier provides an additional point of insulation which is reflected in their growth in Q2 and Q3 despite overall industry declines. At its core, BBWI customers are higher quality customers than the typical mass customer. Their customers are willing to pay up for quality and look to purchase on a recurring basis.
BBWI is also clearly the highest quality/most focused player in the mass/masstige space. An interesting Mintel survey said the following regarding candle shopping attitudes and behavior:
Regarding new scents, no one in the industry comes close to BBWI’s abilities. Beauty Park allows them to launch 6,000 new SKUs per year and more than 250 fragrances annually. This is reflected in the continued changing assortment of their products as the seasons change. Meanwhile, its chief competitors have other worries. Yankee Candle is part of Newell Brands and only reflects ~10% of Newell Brands' total revenue. Yankee Candle has also closed 30% of its store base and is now shifting its distribution to mass locations. In the mass industry, shelf space remains the limiting factor which prevents mass players from producing a wide variety of scents that are updated through all seasons (only have room for the top-selling products).
Boiling all of this down to a couple of key points we see the following which gives us confidence in BBWI’s ability to sustain its growth in Home Fragrance:
The industry is based on a replenishment model and is relatively low-ticket meaning it should not be impacted as hard as big-ticket durables will be by a wallet share shift towards services.
Many of the gains seen in COVID have already been lapped on the quantity side as seen by the industry-wide revenue declines in Q2 and Q3 (revenue likely understates quantity declines due to pricing increases).
Based on customer counts, BBWI was not the player who acquired the incremental low-quality customer in 2020. Their retention rates on new customers confirm this (higher than pre-COVID).
BBWI's outperformance in 2021 and over the last decade is indicative of its ability to drastically outperform the industry regardless of the environment.
The more difficult aspect of the equation to handicap is the pricing side of it. Pricing increases are more macro-driven than any bottom-up reason specific to BBWI. Price has benefited from a combination of PCE expansion, supply chain disruptions, and a wallet share shift towards goods and away from services due to COVID restrictions. Longer-term it is likely that the wallet share of goods shifts back to pre-pandemic levels and supply chain disruptions ease. However, PCE expansion is a rebasing of sorts driven in part by increases in wages. The Federal Reserve forecasts from December 15th assume 2+% PCE growth per year off the 2021 base.
Thinking through pricing increases, there are two primary levers to drive pricing increases:
Higher Sticker Prices
Reduced Promotion (both quantity and depth)
BBWI and most retailers have benefited from both aspects. Looking longer-term, the promotional decreases are the more unsustainable side of things. However, despite the impacts, BBWI should be able to lap this and continue to grow as we will discuss below:
Higher Sticker Prices:
This is straightforward, BBWI has seen higher sticker prices across most of their categories since the pandemic began. Although promotion will be discussed separately, sticker price increases flow through to promotion (i.e., Buy 1 get 1 free when the price was $24 vs now at $25).
BBWI has consistently been able to grow sticker prices over time due to high-quality products, customer loyalty, and the replenishment nature of their products. This quote from management regarding the ability to take price reflects this as well:
“We know that this brand has a unique positioning around masstige, and we know she wants the accessibility of it. But typically, she's very willing to pay if we provide her with the emotional content that she desires.” - 9/10/19 L Brands (BBWI) Investor Update
Considering their pricing power and above median income customer base ($80k+ median household income), these pandemic pricing gains should prove sustainable, and they should be able to continue growing off this base (although muted in 2022). Looking historically at BBWI’s unit pricing increases and how they fared over the last 2 years, we see the following:
Even prior to COVID, the company had strong pricing growth across all its categories. This was only exacerbated in the promotional category as they marginally reduced the depth of promotion each year. At the end of the day, BBWI is a share gainer that wins primarily due to quality, not price. It is not a share donor that caught a bid due to increased spend which will falter when wallet share shifts back towards services. Additionally, the fact that Yankee Candle grew pricing while closing its stores and moving more of its sales to the mass channel speaks volumes to the pricing power of a brand in this industry.
Lastly, this quote from management on the Q3 call regarding the customer reception of the pricing increases (and reduced promotion) confirms this:
“We have not seen negative customer reactions to this point in terms of those changes that we’ve made either to tickets or to promotional levels. And we’ll continue to do more of that.” - 11/18/21 BBWI Q3 2021 Call
This is the more nuanced of the two levers. It is evident that the promotion levels will increase from 2020/2021 and management has said as much. Promotion has always been a strong driver of BBWI sales as it generates traffic and gives store associates the opportunity to drive higher conversion and increased basket size. As a result, cutting down on promotion permanently would be a poor strategic decision.
However, the depth of the non-major promotions should change longer-term. As seen by the table above, the common regular “top offers” (can be found any day of the year) have seen strong unit price increases that should prove sustainable in the same manner as the sticker price increases.
Knowing this, we now think about quantifying the impact of reduced promotion and how much they will have to give back. For now, we will focus on revenue and will discuss the impact of this on margins later.
Per management commentary, the impact of reduced promotions drove half of the company’s gross margin expansion in 2020 when gross margins expanded from 45% to 49%. Assuming a 100% flow through of reduced promotions/pricing from revenue to merchandise-level profit we can solve for a rough estimate of how much revenue was impacted by reduced promotion as seen below:
Solving for the revenue impact is relatively difficult, but the calculation above should be directionally correct. It is more likely than not overstating the impact as some of the promotional changes impact margin without impacting revenue (Buy 3 Get 3 promotion changing to Buy 3 Get 1 has no impact on revenue but increases margin). However, for the sake of conservatism, we assume this number is accurate.
Now that we have the impact roughly quantified at $503m on a full-year basis, we must figure out how much they must give back versus how much they can maintain into the future. There are two important factors to consider:
BBWI has already given back some of the benefit from peak levels in Q2 and Q3 per management commentary.
Some of the benefit will be kept through higher prices and lower depth of promotion vs pre-COVID levels.
Management has indicated that they have given back about 1% in merchandise margin in each of the last 2 quarters vs 2020 levels. Using similar math to the above we calculate that they have already given back ~$77m of the benefit thus far. Based on management commentary there has been even more give-back in Q4 (~1.5%), which at management revenue estimates implies -~$128m of give-back. This means going into 2022, the revenue “over-earning” portion at risk is $295m.
We also know that BBWI has implemented pricing increases across major products and reduced the depth of many of their more common promotions. As discussed previously, much of this improvement should prove to be sustainable. Looking at our table above, the impact is roughly 2-4% on the sticker price side and rolls through a bit higher on the promotional side. If the sustainable impact is pegged at 2% (low end of sticker price 2019-2021 CAGR, to factors in cost inflation in margin), around 26% (2/7.6) of the gains should be sustained. Factoring this in as well, the revenue at risk is now $295m - $132m (503 * 2/7.6) = $163m.
We assume this $163m and an additional $50m in stimulus benefit (per management) will be given back in 2022.
Long-Term Growth Algorithm
With much of the short-term puts and takes discussed, the next question is how to think about the longer-term growth prospects for this business. Typical retail math can be broken down into five factors: Average Unit Retail (AUR), Units Per Transaction (UPT), Traffic, Conversion, and Store Count. Since this business was treated as the secondary focus for much of its life within L Brands, we have limited data on these drivers from 2013-2019. However, taking data points from management and expert calls we can triangulate a slightly different set of drivers: Store Count, Customers Per Store, and Revenue Per Customer. For the sake of simplicity, we calculate Comp including digital sales since management has stated that the margin profile between a digital sale and a store sale is the same at the operating margin level. How these drivers have progressed over the last couple of years prior to COVID based on our estimates of customer count can be seen below:
For information regarding the changes that occurred in the business around 2018 that drove their return to customer growth, see Appendix A.
As can be seen from the chart, spend per customer growth has remained very strong for the last 5 years. Growth has slightly muted over the last couple of years, likely driven by new customer growth. Spend per customer is driven primarily by converting single category customers to cross-category customers (3x single-category spend) and pricing increases. We believe this historical algorithm provides a good reference point for the potential growth equation of the business post-COVID normalization. Although growth may be at a slightly slower pace, we see runway for the following post-2022:
Store Count Growth at ~1%
Customers Per Store growth in the LSD%
Customer Spend Growth in the MSD%
We attempt to justify each of the following below:
Store Count Growth
This is likely the most straightforward of the assumptions. The current management strategy is closing around 40 stores and growing about 60 stores each year as they shift from mall locations to off-mall locations and grow their store count. We take management’s guidance of LSD % square footage growth to indicate roughly 1% store count growth based on the historical results.
Customers Per Store Growth
Thinking through COVID on a 2-year stack, the customer growth comes in at a CAGR of ~7%, which is a bit above 2018 and 2019 levels (~5%), but not much higher. Additionally, the retention rates on these new customers display that these were high-quality customer acquisitions as seen below:
“Again, we gained -- what this is all telling us is that, obviously, we gained customers here during the pandemic. Some of that, obviously, through soaps and sanitizers. But as we're now lapping really that the extreme of those time frames in Q2 and Q3 of last year, we're seeing very nice retention rates. Our retention rate on customers is actually higher than it was pre-pandemic even on a much higher customer base. So that's great.” – 11/18/2021 BBWI Q3 2021 Call
Thinking through the factors at play over the last year, there is nothing to suggest that they cannot sustain this growth.
The Home Fragrance industry has been struggling in the last two quarters of 2021
BBWI has significantly reduced promotion (tends to be one of their primary customer acquisition funnels).
Despite both “headwinds”, they have rapidly grown the customer file this year.
Additionally, digital has emerged as a new customer acquisition funnel. Triangulating management commentary we can solve for the fact that digital drove 4m new customers in 2020 (customers who had not purchased from a store or website in the previous 2 years). This is unprecedented for the business, and although heavily driven by the COVID environment, it is indicative of the emergence of digital as an additional funnel as they have now properly invested in the platform (website visits have remained strong in 2021).
The off-mall shift also remains underappreciated. Historically, BBWI was primarily in malls, and despite continued mall traffic declines, BBWI was able to hold traffic flat or even grow. These off-mall locations are primarily in lifestyle centers and strip malls. Although meandering traffic will naturally be lower in an off-mall location, BBWI’s historical outperformance of mall traffic levels reflects the fact that they are not reliant on it. Additionally, data points from management indicate that off-mall locations have higher growth, higher margins, and higher sales per square foot than Class C and D malls which BBWI is exiting. The following from a former confirms no noticeable difference in new customer-ship between off-mall and mall locations thus far.
“But I think that the interesting thing about new customership is that it is fairly consistent in the store groupings. Because it's driven by word of mouth, it's driven by these overt deals, whether it's a mailer or it's those Try It To Believe It Days.” – Former Associate Vice President Planning & Allocation at Bath & Body Works
They try to place off-mall locations near other major stores such as Target or DSW which drives some meandering traffic. In fact, the nature of this traffic has proven to be beneficial for expanding the men’s business:
“There's something about the lifestyle centers, where the meandering is, I think, more relevant and more broad in terms of the customer base in gender and age. They've got families that are going out to the cheesecake factory, for example, and then walking around, and you can see it in those stores that the men's business is growing faster. So to me, it's a really good signal that there is probably a female customer who's there with her family and bringing in other family members to shop…The hard data would be though that those stores and those lifestyle centers are growing the men's business faster. And those stores themselves are growing faster overall.” - Former Associate Vice President Planning & Allocation at Bath & Body Works
The key limiting factor remains population/their target consumer base. Across the US and Canada, there are roughly 160m women in the 15-80 age range. BBWI also tends to target the slightly above median household income population which would cut the TAM by 50%. However, it would be reasonable to assume that the $50k-$75k household income population remains a potential customer for the business which would mean the TAM is around 63% of the total women. This implies a TAM of 100m versus their current customer base at around 65m.
There is also room for expansion into the men’s business as briefly discussed which would expand their TAM. BBWI cites 60% brand awareness of men in the 18-59 age range. As it stands today the men’s business is around 6-8% of revenue (~17.5% of body care) but is the fastest-growing segment in body care.
Taking this all together, we assume ~2% customer per store growth per year (~3% total customer growth per year) as a sustainable level for the coming years. There are numerous positive levers at play here which give us confidence in BBWI’s ability to continue to grow its customer base. However, as they continue to penetrate the TAM, their ability to grow customer count will continue to slow hence why we assume slower growth than pre-COVID levels.
We have already briefly discussed this lever in the COVID Impacts section. The ability of the company to grow pricing on full-price and promotional selling pre-COVID provides a benchmark for their potential to continue to grow price post-2022. The only other point of reference to keep in mind is the price of their competition as that will remain a limiting factor (do not want to increase prices so much that they are too expensive to be considered “masstige”). As can be seen below on pricing data from a couple of major candle players, they are priced at a reasonable level above the mass players even on a pre-discount basis (although moving to the higher end on a per oz basis).
Yankee Candle’s ability to grow prices despite their store closures and shift to mass distribution (increases competition for each sale) presents a reasonable amount of credence to a 2% baseline. Candles also tend to be one of BBWI’s more “expensive” products as they have continued to grow ticket over the last couple of years (with little impact to demand). There should be even more room for price increases (and reduced depth of promotion) in other categories allowing us to underwrite a 2-3% pricing assumption.
Further, BBWI’s pricing model remains highly effective at capturing the marginal $0.50 when the consumer is indifferent while not overpricing and alienating them. They constantly test marginal price increases in small batches at different locations and can pinpoint the impacts it has on volume and if there is any customer outrage. This allows for optimized changes and should help support our pricing assumption.
Units Per Customer Growth
Historically, this has been one of the business’s strongest drivers and we believe this trend will continue. Regarding the historical growth, at its core, it was driven by an expansion in cross-category customers. The following from a former portrays the magnitude of the increase from 2010 to 2019:
“I'm not sure on the annual basis, but it's around a third of the customers on any given day buy into multiple categories, both categories. And part of the way that they're building that from, frankly, not even much more than a 0% space that it was, it was a really bifurcated customer before the early 2010, '11, and it's grown ever since” – Former Associate Vice President Planning & Allocation at Bath & Body Works
Based on management-provided data, 60% of the current customer base is cross-category (annual basis). This is up from the pre-COVID level which was 55%. However, this is likely understated since they have had a large increase in customer count, and most new customers start out as single-category customers.
Although 60% is a reasonable penetration level, there still exists runway for them to continue to expand the cross-category customer base and expand units within the cross-category base. We view the following as the key levers at management’s disposal:
E-Commerce and Off-Mall Distribution Shift
We touch on each below:
Despite their best-in-class customer loyalty, BBWI does not have a fully rolled out customer loyalty program. They have been piloting it in several markets this year and the results have been overwhelmingly positive. Management has indicated that they plan on rolling out the program across all stores in 2022.
As of January, the program is currently available in 10 markets, up from 4 at the Investor Day (July). This means It is available at 350 of their stores (out of 1750 expected at YE 2021). However, download data remains very strong with the app consistently being one of the top 25-50 apps in the shopping category over the last 90 days (on par with Ulta and well above Sephora) as seen below:
Although it is partially benefiting from the initial launches leading to higher downloads, this success remains quite impressive considering it is only available in 20% of their stores.
It will be interesting to see if management provides any additional commentary on the results of the loyalty program on the Q4 earnings call now that they have rolled out into more markets. At the Investor Day, management stated that spend per loyalty member was 30% higher than non-loyalty members. As an additional reference point, Ulta stated that their app users spend 2x as much and visit 2x as more often than non-app customers.
The mechanics of the program, as with most, are meant to drive higher unit sales even if it is at the cost of slightly increased promotion. The current BBWI program is based on a point system with a customer receiving a point per dollar spent. At 75 points they can redeem any product of their choice that costs up to $14.50 in value (Only costs BBWI ~$2 based on their pre-discount merchandise margin).
Looking into the future, there remains a number of potential ideas BBWI can pursue within this program:
Tiered membership (like Ulta’s program) will allow them to reward their “zealot” customers and incentivize higher and more consistent customer spend.
Use of the notification function of the app to alert customers to new releases and promotions which should drive traffic/conversion.
The app also provides another method they can target their customers as they can show tailored purchase options to each customer.
Potential for reward targeting (i.e., provide single-category customers deals in other categories to drive cross-category customer penetration) similar to BBWI’s current email marketing tactic.
Although it is still in early stages, we view the loyalty program/app as a strong potential driver of units per customer and revenue even if it does cause a marginal hit to pricing.
This program was briefly mentioned in their investor day but does not appear to be well covered by the sell-side. They are currently in the pilot stage as can be seen here: https://www.bathandbodyworks.com/m/auto-refresh.html
This program will drive an increase in units per customer as it should increase the efficiency of replenishment cycles. If a product has a 5-week replenishment cycle, a customer may previously take 6 weeks to replenish due to forgetfulness or a lack of time. This should significantly reduce that inefficiency and continue to drive units per customer.
Although they are providing a discount of 20% when the customer is purchasing $30+ of auto-refresh products, this should still generate growth to revenue as the basket size minimum drives efficiencies across multiple replenishment cycles.
There are two primary levers for new products: adjacent products and new lines.
Adjacent products are straightforward, and this has been something BBWI has been doing for years. The continuation of this seems realistic due to the numerous potential adjacent products and the read and react capabilities allowing for optimized testing (ability to “chase” successful products).
BBWI has announced that they are working to develop green/clean products which should help continue to drive units per customer growth (and pricing), and potentially introduce the company to a new customer demographic. The rollout of spray sanitizer in March 2020 due to COVID and their recent rollout of bar soap provides a reference point for their ability to continue to launch new adjacent products.
Brand new lines in sub-categories that they currently do not have products in (i.e., hair care and skincare), are something that the market is very skeptical about. Based on our initial research we had a similar view. BBWI had previously tried to enter the hair care and skincare lines with a wider product set but had struggled and ended up discontinuing many of the products as they were not successful enough to warrant shelf space. General customer response appeared to be that the hair products were not that great with many customers stating issues such as hair loss after usage.
With the shift to off-mall and increased penetration of digital, shelf space is no longer as much of a limiting factor. Management announced at the investor day that they were going to start piloting products in these categories to see if they could profitably pursue them. Despite our initial cynicism, we noticed that the products have performed well in their pilots based on our data. Additionally, reviews seem to indicate that many of the previous issues customers saw have been fixed.
See below for a full list of new products (adjacent and new lines) that were available on the e-commerce site (have indicated they are also doing in-store tests so we do not have data on all new product tests) and some performance metrics:
We were able to use google advanced operator search to find data on the out-of-stock items as these items are no longer on the site, but the links are still active (hence how google can find them).
Although the out-of-stock datapoint is interesting it is important to recognize that part of the reason will just be very limited inventory in their new pilot tests (i.e., shampoo, conditioner, masks). Most of the adjacent products (deodorant, hand wipes, bar soap) tend to be simpler to produce which partially explains why they may not be out of stock. Review counts for top BBWI products on the website are in the 500-1000 range based on what we have seen. With smaller ticket items (i.e., hand wipes) the review counts tend to be quite a bit lower on average. A rating above 4.5 appears to be solid when looking across BBWI’s other products.
The key takeaway here is the generally positive response across all of their new product tests. This is indicative of initial success and was very surprising to us considering the market view and how they had fared previously in many of these categories. The skincare and hair care TAMs are very large ($21.2b and $13.7b respectively per Euromonitor), and although it is difficult to underwrite meaningful success this early, we view this as a very positive sign.
The company has a history of successfully advancing into adjacent products. With the potential to continue doing that and the upcoming addition of green/clean lines, we view new products as an underappreciated driver of units per customer. Further, the initial success of shampoo, conditioner, and masks is in stark contrast to the prevailing market sentiment providing another potential growth lever.
E-Commerce and Off-Mall Distribution Shift
BBWI has historically been a mall-based retailer. However, over the last couple of years, they are shifting to off-mall locations which tend to have higher square footage. Additionally, they are finally prioritizing e-commerce. For years, they had let e-commerce be a side project as Les Wexner (Former CEO of L Brands) did not believe e-commerce could be successful. This means they did not invest in it when several of its competitors were (did not offer many products and promotions to digital consumers). However, new management’s focus combined with COVID allowed the company to reach scale in its e-commerce business. The following chart of indexed visits for BBWI and Ulta over the last 9 years reflects this underinvestment and then catch-up during COVID:
Although there has been a traffic drop-off with the reopening of stores and reduction in capacity restrictions, e-commerce has remained strong. Data indicates they are down around 10% YoY in terms of web traffic through Q3 and Q4.
The rise of e-commerce and shift to off-mall provides multiple benefits. With their mall-based footprint, BBWI was often constrained on SKUs, and it became difficult to meet a wide variety of customer fragrance needs and display many different products at the same time. However, the shift to off-mall creates square footage growth which reduces the shelf-space constraints at play. Additionally, e-commerce gives them an “infinite shelf”. The testing they have done with new products is reflective of this. The impact of e-commerce is also visible in the data. Management stated that e-commerce basket sizes are $10 larger than in-store baskets. Additionally, data indicates a dual-channel customer spends 3x a store-only customer.
We briefly touched on traffic levels in off-mall locations and why we do not believe that will be an issue. However, we also wanted to mention Ulta as a case study as ~90% of their stores are at off-mall locations and they have shown very strong comps over the last decade (and are expected to continue to do so into the future). In fact, if we look at the market share of the Beauty and Personal Care Industry by distribution channel, specialty retailers have been directly taking share from mass merchandisers (most off-mall locations are near a mass merchandiser). As of 2020, Ulta had ~26% of the specialty retailer Beauty and Personal Care market (BBWI is 17%).
Although data displays the strong success of the e-commerce business, they are still in the early stages as a result of the previous underinvestment. For example, they only have BOPIS capabilities in 550 of their stores (up from 100 at year-end 2020). Additionally, e-commerce penetration remains low, with only ~27% of their customers being digital customers in 2020. A large portion of the growth in customer spend in 2020 was driven by the increase in e-commerce penetration and the natural benefits of increased shelf space and convenience.
Management has shown a focus on improving the e-commerce product and is targeting up to 40% of their revenue being digital long-term (vs 23% YTD). As a result, we view this growth as a sustainable underlying trend considering the opportunity for further improvement to feature parity with their comps, significant runway to grow e-commerce penetration, and continued shift from Class C and D malls to off-mall locations (almost 50% of store count today).
Takeaway: Taking all these drivers in combination, we see the potential for ~3-4% unit per customer growth. This puts the total customer spend driver (units + pricing) at 5-7%. Our customers per store estimate brings us to a 7-9% comp and the 1% store count growth puts us at 8-10% growth on North America top-line per year.
Top-Down Sanity Check of Growth Algorithm
In light of our estimated growth prospects, we took a look at top-down numbers to sanity check our assumptions:
BBWI has shown a consistent ability to take share across all categories we could track over the 2011-2020 time period. They are also the #1 brand across both of their major industry categories and are #1 or #2 in all of their core industry sub-categories. We take a top-down view by analyzing each of the industries individually.
Beauty & Personal Care (Body Care)
This industry primarily covers BBWI's body care segment (liquid soap being in the soap and sanitizer segment). For starters, underlying industry projections are strong across the board on all the sub-categories except for fragrances. It is also interesting to note that BBWI accelerated its share gains industry-wide in 2018 and 2019 after refocusing on it in late 2016/early 2017 as seen by the following management commentary:
“but we also saw body care start to build momentum during the quarter. And I think that's a direct result of the investments that we've made into that business or made into that category.” - 5/18/2017 L Brands Q1 2017 Call
Looking forward, we see two underlying drivers that will allow BBWI to continue taking share.
Specialty Retail/E-Commerce Taking Share in Beauty Distribution
Prior to COVID, there was a meaningful shift in distribution channels for beauty which was evident in the data as seen below:
The shift in 2020 happened due to store closures by many of the specialty retailers and a rise in their e-commerce businesses (internet retailing includes e-commerce from every player). The continued shift towards beauty specialists and e-commerce should prove to be a positive trend for BBWI as they benefit from being a scaled player in both segments (B&M retailers like drugstores and department stores should continue to cede share). From 2015-2019 BBWI held share within specialist retailers constant at ~17%. However, there was a drop from 2015-2017 and a subsequent recovery in 2018 and 2019 post their reinvestment in the body care segment.
Ulta currently stands at 26% of the beauty specialist retailer market. Although they do target a different set of sub-categories, their analyst day guidance provides a reference point for the beauty specialist (and e-commerce) category growth. Ulta guided to a 5-7% revenue CAGR over the next 3 years.
#1 Brand with Runway to Continue Taking Share
The other interesting trend we noticed in the data is that the prestige brands are losing share and BBWI is methodically taking it in the total Beauty and Personal Care industry:
With an already #1 brand when operating in only a select portion of the market (~20-25%), the potential for BBWI to introduce new products remains very strong if they can do so without tarnishing the brand (pilot data thus far indicates they are doing so). Many of the share losers throughout this have been the prestige brands (i.e., Estee Lauder and L’oreal) and the share gainers have been the mass/masstige players (i.e., Dove and BBWI).
Over the last 2-3 years, BBWI has accelerated its industry-wide share gain to 15-20bps. At ~3% share vs a current ~20-25% target market (as a percent of total Beauty and Personal Care), BBWI sits at around 10-15% share in their core categories. This indicates that they are still far from saturation levels. Considering the many drivers we discussed to grow customer count and units per customer, we view a continued 13-15bps share gain as realistic. This implies a CAGR of roughly 7.4% on the body care segment of the business.
The industry growth rates we are seeing via Mintel seem somewhat aggressive despite the potential for a rebasing as we discussed earlier. It is likely industry-wide growth stagnates for the next year (down quite a bit in Q1, however) and may even see declines due to pricing pressures. Longer-term, however, 2-3% does seem reasonable. Pre-COVID the industry shifted from no-growth to MSD% growth on the back of increased importance placed on wellness and mental health. This will likely remain an underlying trend that can help provide a level of support to the industry.
However, as discussed previously, we do not think BBWI is all that correlated with the overall industry and has shown an ability to drastically outperform it. The key limiting factor here will be market share. Based on calculated data using Mintel industry estimates we arrive at ~30% share. This is likely overstated as management has indicated that their home fragrance target market is ~$11b. On an $11b TAM, BBWI comes in at around 23% share.
Although it is reaching a relatively high level of penetration there still exists some runway. Particularly because we tend to view BBWI as almost creating its own demand more than even taking share from its competitors. ComScore data from a couple of years ago indicated that only 3.1% of BBWI unique visitors also visit Yankee Candle. Although this is partially driven by the large difference in website traffic, it is representative of the fact that they often aren’t directly competing with Yankee Candle for customers.
Additionally, considering the trends of the other major industry players, there does not seem to exist a legitimate competitive threat to BBWI in their segment of the market. Private label is doing well, but it will never target the same audience that BBWI does due to quality and emotional perception (private label has still underperformed BBWI over the last 5 years despite starting at a lower base). Glade has also been rapidly losing share and this is a minor business for the parent company (5% of SC Johnson sales per MULO scanner data). Yankee Candle has also been struggling as we discussed previously.
The only way someone would be able to legitimately enter BBWI’s market is if they were to have a large enough brand to justify its own stores, or if mass rapidly expands the size of its candle section and invests heavily in the experience (seems unlikely considering the stark difference between a BBWI store and a mass store).
Newell Brands management said the following regarding their store closures indicating the difficulty of properly operating a similar concept to BBWI:
“The problem with that business [Yankee Candle] several years ago was that the retail stores were showing traffic decline. The profitability of many of the retail stores was very low” – 2/24/2021 Newell Brands at Truist Securities Consumer Symposium
With this in mind, we assume a continued 200bps of share gain implying a 9.9% CAGR to Home Fragrance revenue. However, our primary takeaway is that trying to analyze this on a top-down basis does not make as much sense due to the lack of correlation with the industry.
Soap and Sanitizer
This represents the toughest category to underwrite due to the lack of industry data and general outlook post-COVID. The industry data on liquid soap that we do have is indicative of growth post-2021 as we discussed previously. Although we can picture a reasonable case for this, it is difficult to confidently bet on.
On the market share side, BBWI tends to have a very high share in the liquid soap category, however, they are expanding into other categories. They released spray sanitizer in March of 2020 as a result of COVID and rolled out bar soap around 9 months ago. If we were to assume roughly flat industry growth for the next couple of years post the 2021 declines, there is a reasonable runway for BBWI to grow around 5% with product expansion and general market share gains. Their massive success in liquid soap and extremely high market penetration does provide a bit of credence to their ability to grow in adjacent categories and take share in existing smaller categories.
Takeaway: Putting this all together using a rough idea of the revenue split in 2021 (45/40/15 between Home Fragrance, Body Care, and Soap and Sanitizer respectively) our assumptions imply an 8.2% revenue CAGR post-2022 which is slightly below the midpoint of our bottom-up estimates.
Management and Investor Day Targets
The current CEO of standalone BBWI is Andrew Meslow. He was formerly the COO of BBWI when it was a part of L Brands (Nick Coe was CEO). Thus far his public track record is relatively small, so it is difficult to have a strong view of him. However, BBWI has outperformed anyone’s expectations over the last decade, and based on transcript commentary, he played a large role in that. Additionally, he seems to have a strong handle on the dynamics of the business and is prioritizing growth levers that were previously disregarded (i.e., digital). Based on his brief history as CEO, he has done a good job setting reasonable guidance and then beating it as seen below.
This combined with his upfront transparency on a lighter than expected January (despite a better-than-expected November and December) gives us confidence in the trustworthiness of his Investor Day targets.
The 3–5-year Investor Day Targets BBWI laid out are as follows:
LSD-MSD% Comp Growth Per Year
LSD% Sq. Footage CAGR
High Teens-Low Twenties % International Revenue CAGR
HSD – Mid-Teens % Digital Revenue CAGR
MSD-HSD% Revenue CAGR
$10b in revenue within 3-5 years
MSD-HSD% Operating Income CAGR
Low-Mid Twenties % Operating Income Margin
For reference, this compares to our 9% revenue CAGR and 8% EBIT CAGR estimates through 2026. He has also said the following which implies in-line performance with our estimates post-2022:
“But if I'm thinking more about 2022 and beyond, again, the 10-year track record of either the 5- or 10-year track record of BBW prior to 2020 was top line compounded average growth of between 8% and 9%, with stores delivering in kind of the mid-single digit range and direct delivering in the 20-plus range. I think from a modeling standpoint, that's very much the sweet spot that we would be intended to go back to.” – 12/2/2020 L Brands (BBWI) at Morgan Stanley Global Consumer Conference
Near-Term Trading Setup
The near-term setup remains one of the most frustrating parts of this investment with the headwinds over the next year. However, we believe recent management commentary regarding Q4 and the market reaction has significantly derisked the situation.
Going into 2022, there will be tough comps for BBWI considering their growth over the last 2 years. We have laid out our math behind the promotion give back on revenue earlier in the writeup, and we expect a significant decline in margins leading them near pre-COVID levels (may prove conservative considering the revenue base expansion). However, recent price action has significantly improved the catalyst path.
With their recent guidance update, Q4 should be a wash barring a poor 2022 guide. Post the Q4 guidance update, the market reacted negatively with the stock down 14% since. However, the market reaction appears to primarily be a result of lower-than-expected margins driven by inflationary pressures. These are near-term pressures and benefit the catalyst path as they reduce the difficulty of the Q4 (and full-year) comp next year.
Based on our work, we believe BBWI has roughly 30% incremental EBIT margins even in a normalized environment. However, we do not bake in a legitimate margin expansion story in any of our estimates since management has indicated that they will look to continue to pass on most of this to the consumer. With the Q4 margin decline and subsequent market reaction, the probability of a negative market reaction next year due to the declining margins (which we always expected) has been significantly reduced.
The only negative aspect of the Q4 guidance update appears to be the commentary regarding the semi-annual sale coming in below expectations. However, sell-side follow up with management indicated the following as key factors to consider:
Leaner than planned inventories in key categories due to outperformance in the holiday period versus expectations has hurt the semi-annual sale performance.
Potential impacts of Omicron on store traffic.
Management’s Q4 revenue growth update embeds a highly conservative assumption for January which only makes up 15% of the sales for the quarter.
Google trends data after the start of the semi-annual sale also reflects that this is more of an inventory problem than a traffic problem:
Barring any major new information on the Q4 call, we believe the market reaction has been overdone on short-term fears.
Regarding 2022 there will be tough comps in Q1 with the stimulus give back. However, comps ease up significantly in the back half of the year. We remain cautious over the course of the first half of the year but do see the potential for the company to beat consensus in Q1 as it implies BBWI will be flat YoY on revenue. Adjusting for the reduced promotion (based on our previous calculation) and stimulus benefits in 2021, we believe the consensus estimate implies only 6% core growth in Q1. This comes following Q4 which is likely to grow 9+% YoY on a much larger revenue base.
With this in mind, we see the following as realistic illustrations of the upside/downside case over the next year:
Our downside case assumes a return to pre-COVID operating margins, marginal revenue growth over the next 2 years, and only 10m shares repurchased over the next 2 years. This puts us at $4.35 in EPS and we view a 10x EPS multiple as the worst-case scenario for a brand of this quality (should not be in terminal decline in 2023 regardless of the situation). Our bull case is marginally above our base case on revenue and margins, putting it at $5.86 in EPS. Considering the quality of this business and the runway to sustain 8+% top-line growth and high-teens EPS growth, we believe it should trade at a market multiple. There are no direct comps, but Ulta provides a reference point for the potential multiple of a high-quality retail concept that can sustainably grow comps MSD+%. The primary reason for BBWI’s discount to Ulta even in our bull-case is a function of BBWI’s higher debt load.
Many may point to Ulta potentially being too aggressive of a comp considering its history and position in the beauty industry (higher-quality industry than home fragrance/overall retail). However, we believe placing BBWI in the same context as apparel retailers (AEO, ANF, GPS, URBN) remains misguided. BBWI’s customer loyalty, the replenishment nature of its products, and strong (and potentially expanding) exposure to the beauty category (~40% of revenue) leads us to believe it is comparable to Ulta. Additionally, a continued shift away from prestige brands towards mass/masstige as we saw from the market share numbers should prove beneficial to BBWI while hurting Ulta (top-selling brands include Estee Lauder and L’oreal).
Both companies have also presented 3–5-year targets recently and they are almost the same. Ulta laid out the following targets for the 2022-2024 period:
5-7% Revenue CAGR
3-5% Comp Growth
LDD% EPS CAGR
We also expect BBWI to outperform Ulta over this time period. BBWI has far more levers to accelerate growth (new products, loyalty program, development of e-commerce etc) than Ulta at this point. The one key point of contention is that the industries of Ulta’s product portfolio should outperform those of BBWI post-COVID. Although this is a fair point, we believe it gives Ulta too much credit as they have also seen similar wallet share expansion in 2021 as seen below:
After years of revenue per loyalty member holding flat, they also saw rapid customer spend expansion. It is also important to note that this customer spend estimate should prove conservative since Ulta only gives loyalty members % of revenue data in 5% increments (i.e., 95%+).
Considering the fanatic nature of BBWI’s customers, we believe the customer relationship is similar to that of Ulta’s. In combination with the similar guidance targets, the width of the valuation disparity seems highly unjustified.
Our operating model is as follows:
We have laid out most of the revenue assumptions already. We take the lower end of management’s guidance to project the international segment
We assume 90bp gross margin expansion vs pre-COVID levels (slightly higher overhead adjusted) which is reasonable considering the difference in revenue base.
We model SG&A as a % of revenue coming down about 100bps vs pre-COVID levels. Much of the increases as a % of revenue over the last two quarters was driven by increased investment in fulfillment, COVID safety precautions, and wage inflation. Long-term we use an 18% incremental SG&A as a % of revenue to drive our SG&A assumption which is higher than historical levels as we expect continued reinvestment (15% historically).
The following are our IRR calculations assuming a 15x Fwd EPS multiple (with and without buybacks):
IRR (No Buybacks):
IRR (With Buybacks):
Regardless of the buyback situation, we believe this provides a very compelling opportunity. However, buybacks do add some juice to the IRR and should help with value realization as the EPS CAGR starts to really accelerate.
We also outlined a rough IRR estimate based on management assumptions and no multiple expansion: