Update on LB Puts

We issued an alert early this morning for LP puts, the body of it is below.

In that alert we had said buy up to $2.95, but LB opened down this morning, and we’re adjusting that to $3.50 or lower.

So our revised recommendation: 

Buy to open the January 20, 2017 puts on L Brands with a strike price of $68.5 at $3.50 or lower. Symbol (LB170120P68.5)

 

The puts should be purchased before the company reports earnings after the close Wednesday Nov. 16. I expect management to give subdued guidance for the critical holiday quarter on its conference call Thursday morning.

L Brands is the parent company of Victoria’s Secrets and Bath and Body Works stores. Victoria’s Secret, which generates 60% of revenue and 64% of operating profits, is suffering due to a decline in demand for its namesake push up bras.

The company already lowered expectations to the low end of its 40c to 45c guidance for the third quarter to be reported this week. This was due to disappointing sales, a trend I expect to continue.

  1. Revenue growth at Victoria’s Secret has been slowing. Growth of 9% in the fourth quarter of last year has slowed to 3.5% in the most recent quarters. Fourth quarter last year was boosted by the introduction of more brands than usual. This will make growth especially difficult in the fourth quarter this year.
  2. Product margins saw a boost in fiscal 2016 (ends January 2016) due to the company’s exiting the less profitable apparel business. Without the benefit of this margin boost, profitability will continue to decline.
  3. Income from Victoria’s Secret declined 12% in the first six months of this year, a trend that does not bode well for expectations of 7% growth in fiscal 2018.
  4. Push Up bras, the most profitable and highest priced bras at Victoria’s Secret carry a retail price of $55 on average. Newly popular, less constructed “bralettes” deliver an average of $22 each, 60% less than a push up bra.
  5. Victoria’s Secret needs to sell 2.5 times more units of bralettes to compensate for the decline in more expensive and more profitable push up bras.
  6. L Brands all important dividend may be at risk if the company does not deliver stupendous earnings in the fourth quarter. The company does not generate any free cash flow (cash left over after paying for new stores and big expenditures) in the first nine months of the year. All of the company’s free cash flow is generated in the holiday quarter. Without this cash, the company would have to borrow to pay its dividend.
  7. The January put should capture the company’s report of December sales which typically occurs the first week of the new year.

 

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