This Niche Retailer Is Still a Great Investment

Unlike some of the other major retailers that have seen weakness, L Brands (NYSE: LB  ) is holding up nicely. Over the last five years, L Brands is up more than 400%, while the SPDR SP Retail ETF is up by half as much. However, L Brands announced earlier this week that same-store sales were down 1% for the quarter ended in January. This has pushed shares down 5% over the last few days. However, there are still long-term positives that make L Brands a solid investment. 

Victoria’s Secret has great potential
L Brands is a niche retailer, owning the Victoria’s Secret and Bath Body Works brands. The key for L Brands is that it owns the market for both beauty/fragrance and lingerie stores in the U.S. With its Victoria’s Secret brand, it has market share of more than 40% in its respective market, and Bath Body Works owns 20% of its market.

L Brands is also transitioning its Victoria’s Secret brand back to more basic products. This includes focusing more on intimates and less on denim and other non-core products. L Brands also has a new travel retail concept that could be a key driver for growth. L Brands has been positioning smaller Victoria’s Secret stores in heavy foot-traffic areas, including key areas like airports.

L Brands is also expanding all of its brands into new markets. L Brands is looking to open seven Victoria’s Secret stores and 10 Bath Body Works stores in Canada, where it has a relatively small presence.

L Brands continues fending off competition
Chico’s FAS (NYSE: CHS  ) is another key player in the intimates space. It runs the Chico’s and White House Black Market brands, but also has Soma Intimates. Together, Chico’s and Soma make up more than 60% of sales. But Chico’s is looking to push the Soma brand into more markets. This includes increasing its advertising for Soma.

However, the big difference between Soma and Victoria’s Secret is that Soma focuses on women ages 35 and older. Beyond that, Chico’s has had internal struggles within the company. The company injected too much color into its White House Black Market brand and saw sales and traffic fall as a result.

A dark horse competitor
American Eagle Outfitters‘ (NYSE: AEO  ) Aerie is another key player in the intimates space. But Victoria’s Secret has a well-established brand. American Eagle introduced Aerie back in 2006, but it still only has a fifth of the stores that Victoria’s Secret has. Aerie has only 120 stores, and it makes up just 8% of American Eagle’s overall sales. Meanwhile, Victoria’s Secret has more than 1,000 stores.

One step that American Eagle can take to gain market share is to open Aerie store-in-a-store locations within American Eagle. The key for Aerie is that it caters to young teens. However, that might not be too big of a deal for Victoria’s Secret, since it has its PINK brand. This brand targets the younger generation (e.g., high school and college-aged girls), and the brand continues to gain traction.

How shares stack up
When you compare American Eagle and L Brands from an investment perspective, L Brands wins out again. L Brands trades at a P/E of 15 based on next year’s earnings. The industry average P/E for apparel stores is 25. A P/E of 25 is also L Brands’ five-year average. What’s more is that L Brands trades relatively in-line with American Eagle from a valuation standpoint. However, L Brands’ return on assets is double that of American Eagle’s.

With its strong brand positions and superior operating metrics, there’s no reason that L Brands shouldn’t trade at a higher valuation than American Eagle. L Brands also offers a 2.5% dividend yield as well.

Bottom line
L Brands is a niche company operating in the intimates and personal care/fragrance market. And while these items aren’t necessities, the company had strong sales throughout the financial crisis. With a potential rebound in unemployment, which means shoppers will have more money to spend on discretionary items, shares of L Brands could move even higher. And its valuation is very compelling. For investors looking for a great play in the niche retail business, L Brands is worth a look.