L Brands Stock Slips After Earnings Beat

L Brands (NYSE: LB), parent company of Victoria’s Secret, Bath & Body Works and other chain stores, is a rare find in the retail space. That’s because it’s actually doing well right now, which makes it one of a kind in an industry that is broadly struggling.
Despite the multiple headwinds hitting retail, including the strengthening U.S. dollar, weaker tourism, and unseasonably warm weather, L Brands continues to grow sales at rates well ahead of other retailers.

L Brands and Investor Negativity

L Brands widely beat expectations when it released fourth-quarter earnings on Wednesday. L Brands earned $2.15 per share last quarter, above analyst projections of $2.05 per share. Revenue came in at $4.4 billion, also ahead of expectations. Analysts had forecast $4.39 billion in sales for the quarter.
Despite its beat on both the top and bottom lines, shares of L Brands couldn’t gain any momentum after reporting. The stock fell slightly in early trading, perhaps a sign that investors are afraid of weaker results up ahead. L Brands’ stock is down 13% since the start of the year, so the market is clearly worried about something.
The pervasive negativity may be linked to management’s disappointing forecast. Management laid out a relatively poor guidance for the coming year. L Brands expects to earn $3.90 to $4.10 per share in 2016. At the midpoint of that range, earnings would fall approximately 5% this year.
Still, that would hardly represent cause for alarm, but the stock simply can’t generate any momentum. That’s likely because the stock is coming off strong performance over a multi-year period. Shares are up 47% over the past two years. L Brands has beaten the S&P 500 by more than 40 percentage points in that time, so it’s naturally to see the stock sputter out when its earnings flat-line.
To be sure, unfavorable currency translations are a big reason for management’s uninspiring forecast. The strengthening U.S. dollar is eroding the value of sales conducted overseas, and it also negatively affects  tourism. Still, L Brands is performing well on the metrics it can control— namely, comparable sales.
Comparable sales measures sales at locations open at least one year. It is arguably the most important metric for a retailer. On that measure, there is nothing wrong with L Brands. With earnings, the company announced that it expects a mid-single digit increase in February comparable sales. This was actually above its prior forecast, which called for low-single digit comparable sales growth.
The one quibble investors can have with L Brands is its valuation.

L Brands: Great Company, No Great Stock

After the rally, L Brands stock now enjoys a premium valuation. Shares trade for approximately 20 times its full-year 2015 earnings per share. That’s about on par with the overall market, but on a relative valuation basis, L Brands stock looks pricey. Retailers on average trade for 13-15 times earnings, with some trading for 10 times earnings in this tough environment.
As the saying goes, premium companies command premium valuations. But this is also why L Brands stock continued to drift lower, even after beating earnings expectations. The bar is set high enough that even strong results aren’t good enough.
And, it’s unlikely that investors will continue to pay 20 times EPS for a stock that is likely to experience declining earnings this year. As a result, investors should prepare for the risk of further downside. But, if the sell-off goes far enough, the stock can soon become a tantalizing buy.
L Brands is a well-run company with strong brands. It just needs to come down a bit for the expectations to better match the reality. Investors should sit on the sidelines for now.

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