1. Is the company undervalued?
EV/EBIT: 7.47
EV/Sales: 0.82
Price/Book: 12.5
$VSCO is a well-known brand which trades at a heavily discounted price. Interestingly management is not guiding for a contraction in either earnings or sales. This coupled with a solid balance sheet and strong free cash flow generation makes $VSCO an idea worth looking into.
2. Can I easily explain what the company does?
Yes, they’re a specialty retailer selling women’s undergarments and beauty products.
3. Does the cash flow statement line up with income statement?
Yes, cashflows have been consistently higher than reported earnings:
Most of their excess cash went towards share repurchases, the buildup of inventories, and capital expenditures. Inventories are up ~37% YOY, which is V problematic especially considering that revenues were down 5% YOY. Management is claiming this is a result of longer in transit times, a change of product mix, and inflation. I personally don’t find that excuse believable and would caution investors to monitor inventory levels closely. Other than that, the remaining capital allocation decisions seem logical.
4. Is the Balance Sheet Healthy?
Total Cash: $204M
Long Term Debt: $977M
Current Ratio: 1.04
$VSCO holds little debt relative to their market cap and have north of an 19X net interest coverage ratio. For this reason the balance sheet is not a concern for shareholders.
5. How profitable is the business?
Gross Margins: 45.8%
Operating Margins: 11%
Net Margins: 8.2%
At first glance $VSCO looks like a high-quality business, however margins have been all over the place:
This is not ideal from an investment standpoint and makes it quite difficult to forecast out a normalized profitability profile. With that said $VSCO is implementing cost cutting measures and franchising out more locations, so it wouldn’t be absurd to underwrite double digit operating margins moving forward.
6. What is the company’s growth potential?
$VSCO IPO’d a little over a year ago, and therefore have limited historical financial data. Furthermore Covid-19 has created a lot of noise in the few years of data investors have available. Nonetheless $VSCO is a durable brand and I would anticipate some organic growth via same stores sales and e-commerce. The business can also grow by opening more stores, partnering with 3rd party brands, or via acquisition. Unfortunately any growth rate I assign the company would be little more than a shot in the dark.
7. Is management rewarding shareholders?
$VSCO doesn’t offer a dividend, but have $140M remaining on their $250M share repurchase program. They also issue a fair amount of stock based compensation and if you think earnings stabilize at the current level, then $250M on net returned back to investors is probably a safe assumption. That works out to an ~8% net shareholder yield, which is quite tasty but does require faith in management.
8. How does the company stack up against their peers?
Bath & Body Works, Inc. $BBWI is probably $VSCO’s biggest competitor:
$BBWI EV/Sales: 1.8
EV/EBIT: 7.27
Operating Margins: 24.8%
Both companies trade around the same valuation, although $BBWI has a worse balance sheet and has been a negative growth company. Additionally it’s extremely likely $BBWI is overearning and margins will contract meaningfully. Finally $BBWI is an undifferentiated retailer in an extremely competitive market. This is why I think $VSCO is a more attractive bet.
9. What’s the counter argument?
The bear argument is that $VSCO is overearning and margins will mean revert to mid single digits. Additionally demand will wane as consumers are battling inflation.
I’m inclined to buy into this argument, as the financial results diametrically oppose management’s guidance. Inventories pilling up and sales declining is probably the biggest red flag there is for a retail enterprise. Moreover $VSCO customers are not super high end and will certainly feel the sting of inflation.
10. Is there something I think the market may be missing?
I’m not in love with management’s business strategy. They partnering with Amazon on certain skus and have stated they’re willing to be aggressively promotional if necessary in order to gain market share. Both of those actions will objectively lead to lower margins and potential cannibalize business for their franchisees. This doesn’t seem like a smart decision long term and it wouldn’t shock me if profitability fell off a cliff as a result.
Final Thoughts:
$VSCO has all the makings of a solid value investment; it’s cheap, returning capital to shareholders, should grow organically, and a moaty brand. However I’m not a fan of management, I don’t think they’re bad actors per se but seem to be overpromising by all accounts. Having said that I would love to be proven wrong. If management can delivery on their promises and margins stabilize at double digits, I would definitely revisit the name.
***Disclosure: I have no position in the security mentioned above, nor do I have any plans to purchase within the next 72 hours. This article is intended for educational purposes only and in no way should be interpreted as investment advice