Fitch Affirms L Brands, Inc.'s IDR at 'BB+'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the ratings for L Brands, Inc. (L Brands), including the Long-Term Issuer Default Rating (IDR) at 'BB+'. The Rating Outlook is Stable. A full list of ratings follows at the end of this release.

KEY RATING DRIVERS

The ratings reflect L Brands' strong brand recognition and dominant market positions in intimate apparel, personal care and beauty products, and strong operating results, all of which are characteristic of an investment-grade profile. While credit metrics have been reasonable, with leverage at or slightly below 3.5x since 2010, the 'BB+' rating considers the company's track record of shareholder-friendly activities which could push leverage above this range.

L Brands' strong business profile is anchored by its two flagship brands, Victoria's Secret (approximately 63% of sales and operating income including the Victoria's Secret direct business) and Bath & Body Works (approximately 30% of sales and 36% of operating income); a strong direct business (16% of total revenue); and a growing international footprint.

The company's strong comparable store sales (comps) trends since the recession have been driven by relevant and attractive product offerings and a loyal customer base. Comps increased 5% in 2015, following a 2% increase in 2013 and 4% in 2014. In addition to positive operating leverage from strong comps growth, the company has driven margin growth through efficient inventory and expense management. EBITDA margins in the 20%+ range compare favorably to the broader retail average in the low teens.

The years 2016 and 2017 are expected to be affected negatively by the company's recent actions at Victoria's Secret to streamline operations as well as investments related to grow Victoria's Secret in North America and transition China to a company-operated market (previously franchised). Notably, the company is eliminating certain merchandise categories such as swimwear and certain apparel categories representing a total of $525 million in volume (4% of total sales) beginning mid-2016.

Factoring in the swimwear/apparel volume loss, Fitch expects 2016 revenue growth to be up modestly on flattish comps and 4% square-footage growth, while 2017 revenue is expected to be up in the 4% range on comps of 1%-2% and 2%-3% square-footage growth. The combination of flattish comps, margin degradation on inventory clearance activity and price investments to drive sales in key categories, and investments in the China rollout is projected to yield a 3%-5% decline in EBITDA in 2016 to the $2.6 billion range. However, EBITDA margin is expected to remain in excess of 20% in 2016 and 2017.

The growth of PINK in the U.S., which could be a $3 billion business over the next few years from our estimate of $2.5 billion currently, and the inclusion of the full lingerie lines in expanded Victoria's Secret stores have led to increased productivity per square foot over the past few years. PINK, a collegiate-focused brand which offers intimate apparel, loungewear and related products in vibrant colors and patterns, has expanded Victoria Secret's demographic base by appealing to younger consumers. International expansion provides a strong top-line and profit opportunity by allowing the company to diversify outside of mall-based locations and reduce operational and execution risks through its substantially franchised model (outside of the UK and Canadian markets).

KEY ASSUMPTIONS

--Fitch expects L Brands to produce flattish comps (excluding its direct business) in 2016, improving to the 1%-2% range in 2017, factoring in the loss of apparel/swimwear business;

--Square footage expansion, if executed successfully, could drive overall top-line growth to modestly positive in 2016 and in the 3%-5% range thereafter;

--Free cash flow (FCF) after regular dividends of negative $100 million to breakeven after regular dividends over the next two to three years given increased capex spend;

--Capex is expected to increase to approximately $950 million in 2016 from $727 million in 2015 reflecting new store constructions and square footage expansion and stay in that range thereafter;

--Leverage is expected to be in the mid-3x range with future debt-funded special dividends or share buybacks potentially pushing leverage higher than 3.3x in 2015.

RATING SENSITIVITIES

A positive rating action would require both the continuation of positive operating trends and a public commitment to maintain financial leverage in the low 3x range.

A negative rating action could be driven by a trend of negative comps and/or margin compression from fashion misses, execution missteps or loss of competitive traction. A larger than expected debt-financed share repurchase or special dividend and/or leverage rising to 4x would be negative for the rating.

LIQUIDITY AND DEBT STRUCTURE

Liquidity is strong, supported by a cash balance of $1.3 billion as of July 30, 2016 and the company's $1 billion revolving credit facility. The company has a comfortable maturity profile and Fitch considers refinancing risk low given L Brands' strong business profile, favorable operating trends, and reasonable leverage.

Fitch expects FCF after regular dividends of negative $100 million to breakeven after regular dividends over the next two to three years given increased capex spend. Fitch assumes regular dividends will be increased by approximately 10%, compared with the 10%-25% increase over the last few years. Capex is expected to increase to $950 million in 2016 from the $700 million range annually in 2014-2015, reflecting new store constructions and square footage expansion to primarily support PINK and international growth (square footage to grow by approximately 4% in 2016).

Lease-adjusted leverage stood at 3.3x as of Jan. 30, 2016. Fitch expects the company to maintain a leverage profile in the mid-3x range, and fund dividends and share repurchases with FCF and potential debt issuances. The company's shareholder-friendly posture is a key constraint to the rating.

FULL LIST OF RATING ACTIONS

Fitch has affirmed L Brands' ratings as follows:

--Long-term IDR at 'BB+';

--Secured bank credit facility at 'BBB-/RR1';

--Senior guaranteed unsecured notes at 'BB+/RR4';

--Senior unsecured notes at 'BB/RR5'.

The Rating Outlook is Stable.

Additional information is available on www.fitchratings.com

Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:

--Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation and exclude restructuring charges. In fiscal 2015, Fitch excluded a $78 million gain from L Brands' sale of its remaining interest in an apparel sourcing business. Fitch added back $97 million in non-cash stock-based compensation to its EBITDA calculation.

--Fitch has adjusted the historical and projected debt by adding 8x yearly operating lease expense.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/site/re/869362

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1011150

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1011150

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
David Silverman, CFA
Senior Director
+1-212-908-0840
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
JJ Boparai
Analyst
+1-212-908-0543
or
Committee Chairperson
Monica Aggarwal, CFA
Managing Director
+1-212-908-0282
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
David Silverman, CFA
Senior Director
+1-212-908-0840
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
JJ Boparai
Analyst
+1-212-908-0543
or
Committee Chairperson
Monica Aggarwal, CFA
Managing Director
+1-212-908-0282
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com