Just how perky is Victoria's Secret's strategy?

By Alexandria Sage - Analysis

LOS ANGELES (Reuters) - Victoria's Secret is betting its future on taking its sexy brand into products like workout wear and accessories -- uncharted territories for the lingerie name that could take years to pay off for investors.

By building bigger stores with more floor space to devote to categories like sports bras, yoga pants, even swimsuits and luggage, the chain believes it can get consumers to buy more.

"Is there more room in the drawer for Victoria's Secret?" That's how Stifel Nicolaus analyst Richard Jaffe sums up the central question surrounding the division of Limited Brands Inc. (LTD.N).

Meanwhile, Wall Street is waiting to see whether Victoria's Secret can perk up recently-deflated profit margins and continue to drive sales in an increasingly crowded market. After all, just how sexy is yoga wear, anyway?

"It will be combining technology and fashion and sexy into one," said Sharen Turney, the chain's chief executive, of the upcoming Victoria's Secret Sport line. It could eventually be as big as Pink, the company's $900 million cotton lingerie and sleepwear brand for younger shoppers, Turney said.

Some on Wall Street agree that Victoria's Secret has the clout to pull it off, including C.L. King's Mark Montagna, who sees workout gear as the chain's "next big home run."

"I think that will fuel a lot of growth going forward," said Montagna, who rates Limited shares "accumulate." "Meanwhile, everyone else will be stuck still in bras and panties."

But not so fast, say others. Were the new categories such sure-fire winners, they'd already be in the stores, said Jaffe, who has a "hold" rating on the stock.

Swimwear, for example, now a $130 million business through Victoria's Secret catalogs, is seasonal. Turney said swim will drive new shoppers into stores and provide a counterbalance to holiday sleepwear sales. Still, that business is dependent on having the right inventory at the right time, with little room for error.

J.P. Morgan's Brian Tunick, who rates shares "neutral," said Victoria's Secret might end up disappointed in its five-year plan to grow square footage at stores by 50 percent. He sees few past examples of companies that have expanded their average store sizes in a competitive field and then seen the return on investment they were expecting.

ALLURE OF THE BRAND

There is no question that Victoria's Secret has plenty to boast about. It has world-wide brand recognition, and rivals in lingerie such as J.C. Penney Co. Inc. (JCP.N), American Eagle Outfitters Inc.'s (AEO.N) Aerie brand or Kohls Corp. (KSS.N) just don't have the allure the chain known for its busty models can claim.

And Victoria's Secret's historical performance has been impressive, said Tunick. Stores reap more sales per square foot than the average mall-based specialty retailer, while historical operating margins of 19 to 20 percent are above the 11 to 13 percent range seen by other specialty retailers, Tunick said.

Still, it's getting tougher for Victoria's Secret to match that success. Recent worries, like narrowing profit margins and same-store sales misses -- hurt by unsuccessful bra launches and markdowns this spring, as well as a greater portion of sales from lower-margin Pink -- don't necessarily have an easy fix.

So Victoria's Secret has been steering Wall Street's focus toward its longer-term plans, such as international growth and store expansion, Tunick said.

"That, along with some balance sheet support, will keep the stock range-bound, but fundamentally we're certainly not that upbeat on the near-term prospects," Tunick said.

RISK OR OPPORTUNITY?

Another big unknown concerns international expansion. Limited's purchase of the La Senza lingerie brand early this year could help jump-start expansion abroad, since La Senza already has stores in Canada and licenses in some 30 countries.

Turney acknowledged that international plans are vague, but said a comprehensive strategy will come as the company learns from its domestic pursuits and its plans to put the Victoria's Secret beauty line in La Senza stores.

But some analysts focus on the huge opportunity.

"Victoria's Secret has an enormous amount of share left to take," said Lazard Capital Market's Todd Slater, who rates shares "buy." "I see Victoria's Secret as a significantly bigger business five years down the road than it is today."

But in the short-term, Wall Street waits to see whether the self-inflicted problems earlier in 2007 are permanently fixed.

"This year is kind of a wash," said Montagna. "You buy the stock now for next year."

Limited, which also operates Bath & Body Works stores, recently divested majority interests in its profit-dragging Express and Limited clothing chains and plans to save $100 million per year starting in 2008. The company has solid free cash flow and has increased the amount and pace of stock buybacks.

Wall Street, on average, is forecasting 4.5 percent sales growth for fiscal 2008 -- a figure which includes contribution from now-divested apparel brands -- and 1.6 percent growth for fiscal 2009, compared with the 10 percent gain in fiscal 2007, a full year that included sales from Express and Limited.

A confident Slater says skittish investors should keep the following in mind: "Victoria's Secret's death knell has been summoned many times."