Is L Brands a Good Pick After its Double-Digit EPS Growth?

Is L Brands a Good Pick After its Double-Digit EPS Growth?

L Brands , formerly known as Limited Brands, has enjoyed a good rise since the beginning of the year. The company's stock is up 35.9%, higher than S&P 500's year-to-date gain of 26.5%. In the third quarter, the company also reported a solid operating performance with decent growth in comparable-store sales. With strong third quarter earnings results, should investors consider L Brands as a part of their long-term portfolios now? Let's find out.

Decent third quarter operating performance
In the third quarter, L Brands experienced good growth in operating income and EPS with increases of 7% and 19%, respectively. Traffic was down in the quarter, but the company had higher conversion rates and higher average dollar sales. Both sales and comparable-store sales were also on the rise. While revenue increased by 5%, comparable-store sales enjoyed a 3% growth. The difference between the revenue growth and the comp growth was mainly due to the strong sales in the BBW direct channel.

Victoria's Secret is the largest revenue and profit contributor to L Brands. Its operating income came in at $1.18 billion in fiscal 2012. This was higher than its consolidated operating income, mainly due to the losses in other business segments such as La Senza and Henri Bendel.

In the third quarter, Victoria's Secret enjoyed comparable-store sales growth at 4%. This was driven by double-digit growth in three main categories: bras, fragrances, and panties. In this quarter, the company experienced higher buying and occupancy expenses because of the real estate expansion for two segments: Victoria's Secret and International. For the full year, L Brands estimated that it would deliver low-single digit comparable store sales growth, with the free cash flow of $650 million to $700 million.

Consistent dividend payment but high payout ratio
What might attract income investors is L Brands' consistent dividend payment. At the company's current trading price of $64 per share, the dividend yield stays at 1.90%. Investors should be careful, however, as the dividend payment was much higher than the company's earnings; it carries a high payout ratio of 187%. Moreover, L Brands had negative equity while its leverage ratio was also high at 1.96 times net debt/EBITDA (earnings before interest, taxes, depreciation, and amortization.)

Gap and Hanesbrands have more attractive financial attributes
Its peers, including Gap and Hanesbrands , offer investors more reliable dividend payments.

Leverage ratio

Dividend yield

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Among the three, Gap seems to be the preferred pick. It has a decent dividend yield, a conservative payout ratio, the strongest balance sheet of the three companies, and the lowest valuation. In addition to its good dividend payment, Gap also returns money to shareholders through share repurchases. The company has distributed more than $1.1 billion to shareholders, and it bought back 20 million shares in the most recent quarter. Gap made clear its intention to continuing repurchasing shares by announcing a new $1 billion buyback authorization as well.

Hanesbrands' payout ratio is quite low at only 11%. This is because the company prioritizes paying down its debt level. Profitability will improve and more shareholders value will be generated by its ongoing effort to pay off its spinoff debt. The company announced that it would complete a $250 million prepayment in the middle of December this year, reducing its long-term debt to $1 billion. The company has saved around $20 million in interest payment through an earlier debt reduction. When the debt level has come down to a more comfortable level, I think that Hanesbrands will increase its dividend payment and initiate share repurchases.

My Foolish take
Despite its growing operating performance, I don't think the margin of safety in L Brands' shares is adequate. Among the three, I like Gap the most because of its decent dividend yield, strong balance sheet, and low valuation. Hanesbrands' profitability will definitely improve as a result of its ongoing debt reduction efforts. In the near future, I think that Hanesbrands' shareholders will also be rewarded with a rising dividends and share buyback program.

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