Morningstar’s nod to Limited Brands

According to Morningstar latest research on Limited Brands, management has taken very slow and methodical steps to overseas expansion, which has proven successful. Victoria's Secret has some of the most impressive sales

per selling square feet in the industry, forecast at $721 for 2011.

“Limited's growth of its strong brands, particularly market leaders Victoria's Secret and Bath & Body Works, has been impressive in a difficult retailing environment”, sum up analysts from Morningstar in a recently released note to investors. The focus moving forward is expected to be in the Victoria's Secret Brand and in International Markets.

Thus, while Victoria's Secret will be incorporating more of the Pink brand in additional locations (Pink currently has a full assortment in only 10 percent of Victoria's Secret locations), new store locations with more square footage will add products from adjacent markets, like sport, loungewear, and swim, which we believe is a smart move. Victoria's Secret has some of the most impressive sales per selling square feet in the industry, forecast at $721 for 2011, and we think adding volume in a productive capacity positions the overall company to win. It was estimated that the $2 billion combined Victoria's Secret Beauty and Pink businesses have the estimated combined revenue potential of $5 billion as square footage increases over the next five years, an estimate we find realistic, as it implies 20% compounded annual growth on a business opening more than 150 locations in the next year alone.

It is worthy a note to remember that Victoria's Secret had only 12 international locations in Canada at year-end, which allowed the company to get its feet wet in a different currency, language, and culture without betting the bank. It plans to double that number globally
by the end of 2012.

New markets are similarly being tested using the VSBA (Beauty & Accessories) concept in airport locations to understand new local markets. The company's willingness to open both corporate and franchised locations overseas indicates to us that management is willing to bring in expertise in certain local markets while maintaining creative control and creating a little financial flexibility overall (franchised locations use much less capital). At the beginning of the year, there were 580 international Limited Brands locations, and at the end of 2012, 850 units are expected, driven primarily by growth in La Senza (116 new units), VSBA (128 new units), and Bath and Body Works (44 new units). Despite the international push, the firm stated it believes there is a way to double the revenue in North America by improving on a number of concerns in the business (supply chain, customer experience, product testing). We think financial goals like these might be ambitious in the near term, and may take some time to accomplish.

“We view Limited's margin expansion goals as ambitious, but also more attainable. Management remains dedicated to improving the operating income rate to 15%, and last quarter's operating margin was a step in the right direction, as the margin expanded 200 basis points year over year to 12.5%. The team also makes inventory control a priority, as it is committed to growing expenses slower than sales, which it has done impressively over the last two years. These goals are both achievable, and we would hope sustainable, although it may take a little time to reach the operating income goal”, the investment research specialists conclude on the Limited Brands’ international strategy.

“Limited's shares have had a healthy run recently, and we currently view them as overvalued, trading at a significant premium to our $30 fair value estimate, though we plan to review a number of the company's key initiatives and their potential impact on our long-term valuation assumptions. We note if the company were to achieve its ambitious revenue growth and margin expansion targets, there would likely be upside to our current fair value estimate.”

AngelaGonzález-Rodríguez