Bath & Body Works Earnings: Operating Margin Stabilization Near, With Potential Expansion in View

Narrow-moat Bath & Body Works BBWI, or BBW, felt the pain of spending normalization in the second quarter. While sales of $1.56 billion kept up with the firm’s forecast for a low- to mid-single-digit decline, the downtick led to cost deleverage, resulting in a 12% operating margin (down nearly 300 basis points). Although sales were 40% higher than the same period in 2019, selling, general, and administrative costs provided a stall in profitability. However, the biggest expense headwind stemmed from technology costs, some of which should prove transitory given that this spending was necessitated a result of BBW’s split from Victoria’s Secret. Thankfully, the gross margin held up well, at 40% thanks to increased average unit revenue and improved merchandise margin, which experienced its first uptick in over two years. In our opinion, this implies the brand intangible asset is holding firm, indicated by consumer willingness to forgo discounting despite widespread concern around discretionary spending.

Management signaled confidence in the back half of the year, offering a modestly improved outlook that includes a 1.5%-3.5% decline in revenue (versus flat to down midsingle digits prior) and $2.80-$3.10 in adjusted EPS ($2.70-$3.10). Given that our preprint projection for 2023 called for a 2.5% sales decline and $2.80 in EPS, we don’t foresee any change to our near-term outlook. As such, we don’t plan to materially alter our $78 fair value estimate and view shares as significantly undervalued. BBW shares have wildly underperformed the broader markets, down 17% year to date as we believe concern around discretionary spending and persistent inflation have weighed on consumer sentiment. However, we still believe BBW can buck the trend through rich product innovation (with laundry set for launch this fall on the heels of a men’s grooming platform), which will bolster product interest and aid the firm’s return to 20% operating margin metrics that we forecast in 2026.