Victoria's Secret Turnaround Went Stealthy, Financials Show

Key Points

• Shares of Victoria's Secret are sliding in the after-market hours of Wednesday evening as the company reports some initially disappointing data in their first quarter 2023 earnings report. 
• The company reported slowing sales and store closings during the year, adding to the negative sentiment. However, the business achieved its gross margin retention during a most challenging year. 
• There is a significant gap between the 'real' earnings and the company's reported earnings, as these special items would show. Adjusting to analyze the real earnings potential of the core business will enable investors to see what happened and where the value lies. 

Shares of Victoria's Secret & Co. NYSE: VSCO are sliding in the after-market hours of Wednesday evening after the company reported its first quarter 2023 earnings results. Initial investor reactions are sending the stock on a sell of as big as 15%. This would mark one of the most significant moves in the store since August of 2021 when the stock declined by 16.7% in a single trading session. The second largest sell-off in the stock comes amid initially negative headlines starting off the company's press release.

As is often the case with initial reactions to earnings results, short-term traders pile into the stock price based on what they initially pick up from the respective releases. However, investors with a long-term mindset will benefit from picking apart what took place in the period by dissecting trends and the financial impacts of the business in question.

By doing just that, Victoria's Secret shareholders will find that there were a few non-core and non-recurring expenses realized in the company, which are in no way reflective of the core quality of business operations and its subsequent valuation. 

The Real Weight of Earnings

Victoria's Secret financials will show that the company went from generating $80.8 million in net income from the first quarter of 2022 to only $725 thousand twelve months later. Of course, this would seem only natural after accepting that the company's sales declined by 5.1%, driven chiefly - and only - by North American stores. Direct sales, which include Adore Me sales, a new acquisition made by management that will come into play later, rose by 10.4% during the period. International sales grew by 18.7%, driven mainly by joint ventures in China and royalties associated with franchised stores and wholesale sales. 

As every industry has its own set of key performance indicators (KPIs), the retail industry leans heavily on the growth and decline rates of comparable sales, as it takes out any artificial development derived from solely opening new stores for the sake of it. In the case of Victoria's Secret, comparable sales declined by 11% on a nominal basis (ex., inflation) and by more than 15% on a factual basis when analysts account for inflationary effects.

As a result of these contractions, management has chosen to batten down the hatches a bit by reducing the number of locations globally. The first quarter of 2022 counted 1,358 stores; a year later, there were only 1,347, reflecting a net closure of 11 sites. 

The discrepancy between the 'real' earnings and the reported earnings comes from a couple of items. It starts with a pre-tax charge amounting to $10.4 million, or $8.2 million net of tax, representing nearly 37% of the company's $28.2 million operating income. The second non-core and non-recurring item comes from a landlord dispute relating to a legal matter from a high-profile store that was surrendered before separation.

This factual estate-related dispute amounted to a pre-tax charge of $21.7 million, representing nearly all of the company's operating income. 

Where the Real Value is

Despite a declining sales year and fewer physical locations to count on, gross margins remained above 35% during the period. Keeping everything the same, the business should have posted similar earnings per share to the $0.93 reported in 2022. If financial conditions were better than the net income amount made them seem, the company would not have been allowed to repurchase up to 7,386 shares in the open market.

These repurchases come off the board's approval for $250 million to be allocated toward buying back shares throughout 2023, hinting that insiders currently believe the stock to be on the cheaper end of things.

If investors add back the non-recurring charges stated previously and keep the same 33.9% effective tax rate, the actual earnings potential for the period could be deduced. Adding back the $18.6 million of pre-tax charges to the $5.7 million of pre-tax earnings reported, investors can arrive at a real income before taxes of $24.3 million.

Taking out taxes at a 33.9% rate, the company would be left with a net income of approximately $16 million, which would have been $0.20 per share, accounting for the generous buyback affected.

Now, there are other non-recurring charges that would have been honorable mentions to add to the 'real' earnings process. Nonetheless, investors should remain on the conservative side of things and stay with the $0.20 earnings per share assumption. Victoria's Secret analyst ratings would agree on the viewpoint of there being more value than meets the quarter, as they have assigned a 121% upside target from today's prices.