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Land’s End (NASDAQ:LE) 2Q24 results were positive, with revenues improving on an adjusted basis on its most important, US e-commerce channel. The company’s gross margins also improved thanks to lower discounting. Unfortunately, most of the gross profit and revenue growth was absorbed by SG&A, mostly going to finance customer acquisition via digital marketing, leaving profits unchanged on an adjusted basis (and down on an adjusted basis for 1H24).
The company’s stock price is up 10% since my initiation Hold article, and now the company trades at a market cap of $422 million (EV of about $660 million). The market cap seems excessive compared to the adjusted net income guidance for FY24 of $9/15 million, even accounting for this quarter’s growth. 2Q24 results point to difficulty leveraging growth if it is caused by higher customer acquisition costs. For that reason, I maintain my Hold rating on LE’s stock.
2Q24 results
Adjusted top-line growth in US ecommerce: When we look at LE’s unadjusted top-line results, the company posted 2% lower revenues for 2Q24. This fall was caused by US ecommerce (60% of revenues) down close to 4%, and Outfitters (20% of revenues) down 7%, offset by International ecommerce (10% of revenues) marginally up and others (licensing and wholesale, 10% of revenues) up 24%.
However, when we look under the hood the situation is a little better. In particular, the US ecommerce segment grew MSD when adjusting for the licensing of the kids and footwear business. Although part of this licensing is reflected in the others segment being up (at higher margins given that it’s licensing revenue), this is still a net positive.
Gross margins improving, lower clearance: Despite revenues falling 2%, gross profit grew close to 9%, via margins expanding 470 bps. The improvement came from moving some revenues from direct sales to licensing (licensing is basically 100% margin), and from lower clearances. The last time I visited Land’s End website, I was received by a large 40% OFF everything sign, whereas this time, clearance is more concealed (you can still find up to 75% discounts, but less prominently).
Profits lost to digital advertising: The company’s adjusted US ecommerce revenues grew MSD, and gross profits grew HSD, or about $12 million. Unfortunately, most of this improvement was lost to SG&A, which increased by $11.6 million. The increase in SG&A was directed towards digital advertising for customer acquisition, professional services, and incentive compensation (bonuses to management).
Focusing on customer acquisition alone (and ignoring a company paying bonus compensation despite posting net losses of $11 million for 1H24), we see a problem with LE’s current growth. If growth is financed via expensive advertising, the return on that increased investment is low for investors and for the bottom line. The company can boost revenues and potentially EBITDA (the two measures under which management is paid bonuses according to the proxy), but investors see little returns in the form of profits. In fact, even when adjusting for restructuring and impairment, the 1H24 season generated fewer operating profits than 1H23, despite growth.
When we look at more organic measures of growth, they are not as great. Google Trends for the US show two years of decline for the brand, the same as organic traffic according to Semrush.
Valuation remains unattractive
Since I published my initiation article on Land’s End, the stock is up 10%. Now, the company trades at a market cap of $422 million. With cash of $26 million, compared to short-term debt of $20 million and long-term debt of $243 million, this leads to an EV of about $660 million.
Land’s End is not a fantastic company. It is a retailer, which is generally a low-margin business (2.8% average operating margin for the past 10 years), exposed to consumer discretionary cycles during a challenging time for this type of company (with more uncertainty ahead). In addition, it has been unable to grow revenues for the past ten years, and only moderately since 2018. The company’s compensation structure for management promotes growth for growth’s sake, with a focus on revenue and EBITDA.
Finally, and most importantly, the company is leveraged, with net debt of about $240 million, or 2.5x the adjusted EBITDA guided for FY24. In fact, today, the company is far away from covering interest expenses, with operating income of $10 million for 1H24 (after adding back impairments), versus interest expenses for $20 million.
In order to hold a retailer with low margins, heavily leveraged, and unable to pay interest from operations, one should ask for a very high return. This is because the risks are high as well. If Land End cannot turn its operations around, the company might face financing problems in the near future. In addition, the leverage and net losses make surviving a more prolonged or harmful economic downturn more challenging. The specific return each reader believes is fair for LE will be different. Given the enormous risk the company faces, I believe 15 to 20% is the bare minimum.
However, when we compare the different measures of profitability, the returns provided by LE are much smaller. The company is guiding for adjusted net income of $9 to $15 million for the year (after adding back restructuring charges). This implies a P/E of 32x in the middle, or an earnings yield of about 3%.
Can LE deliver the remaining 10%+ of yield via growth? I doubt it. First, the company is growing now thanks to digital advertising, but the current trend has only lasted a quarter. Second, the company has historically only been able to leverage margins when demand changed thanks to outside margins (mainly during COVID). As seen this quarter, if the company has to pay advertising to grow revenues, then its margins do not grow (in fact they went down). The best possibility for additional growth is via financial leverage, as every percent increase in operating profits increases net income by much more as interest is covered.
For example, assuming operating margins of 2.5% (historicals), and yearly interest of $40 million, in order for LE to generate an earnings yield on its $422 million market cap of 10% ($42 million net income), it should grow revenues to $3.8 billion, from the currently guided $1.35 billion for this year. These are a little high expectations, in my opinion.
We cannot really consider the situation on an EV basis because we can only access the company’s equity and the company faces real financing risk. However, on an EV basis the situation is not very different, with adjusted EBITDA expected to be about $95 million, which implies cash-NOPAT of $40 million (removing CAPEX of $35 million, SBC of $5 million and taxes of 25%). This yields an EV/NOPAT of 16x, or a yield of 6%, but for the whole capital stack, without the help of financial leverage on growth.
In my opinion, Land’s End trades at very excessive valuations. The company’s equity is very risky, but contrary to that risk, it offers a very small earnings yield, and already absorbs significant growth in the form of a high stock price. For that reason, Land’s End remains a clear Hold in my opinion.
