Known more for sex appeal than sweat, Victoria's Secret is at a turning point

Models walk the runway at the Victoria's Secret Fashion Show on November 30, 2016, in Paris.
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Victoria's Secret wants you to think of its stores as more than a place to buy push-up bras.

As the bombshell brand works to extend its industry leadership beyond racy unmentionables — positioning itself as a formidable foe in sport bras and bottoms — it will need to convince shoppers that it's just as good at selling sweat as it is at selling sex appeal.

By cutting in half the price of certain athletic pants and sport bras, Victoria's Secret is trying to encourage customers to try its budding product lines. This tactic helped the brand ring up a record Black Friday — but it came at a cost. Although sales at its established stores rose 5 percent in November, Victoria's Secret's merchandise margin was "down significantly" over the prior year, management said.

This shift in its promotional strategy is just one of the issues plaguing Victoria's Secret. Shares of its parent company, L Brands, have dropped more than 20 percent this year, as the label leaves behind the stalled apparel and swimwear categories and does away with its catalog.

Meanwhile, a broader fashion movement away from traditional bras to unconstructed bralettes is pressuring the company's sales both internally and externally. Because these items have lower price tags, some investors are concerned VS is trading sales on more lucrative items for less expensive pieces. Also, since they're easier to construct, bralettes make it easier for competitors to muscle in on Victoria's Secret's turf.

While many on Wall Street expect Victoria's Secret to eventually overcome these challenges, they acknowledge the immediate future is likely to be choppy. That includes the critical holiday season, when L Brands generates more than one-third of its annual revenue.

"There are valid concerns," Cowen and Company analyst Oliver Chen, who has an "outperform" rating on the stock, told CNBC. "It's a good long-term position that could have near-term pain."

In its attempt to upend the sport bra market, Victoria's Secret faces a deep bench of competitors. That includes stalwarts like Nike, as well as the more fashionable athleisure brand Lululemon.

Lululemon's growth in the category accelerated in its recently ended quarter, rising more than 20 percent. It's been helped by a rejiggered lineup of looser-fitting tops, which easily pair with the brand's bras. Lululemon CEO Laurent Potdevin sees even more runway to grow the bra category, promising investors "fantastic innovation" in the category next year.

Known less for its athletic expertise than Lululemon, Victoria's Secret's efforts in the sport market is a work in progress, according to Chen. Yet IBISWorld analyst Anya Cohen noted the label has made strides in reworking its sports offerings since launching athletic bras a few years back, when they were more sexy than practical.

"It looks like they're going for function over cutesy a little bit more," she said. "That seems to be a trend that millennials are relating to — the more natural, more simple."

Indeed, that shift in consumer preference is one reason why American Eagle's Aerie brand has taken off. As a leader in the bralette category — a trend that, similar to sport bras, is shaking up the industry — Aerie's body-positive message has resonated with young shoppers.

Sales at that label have been growing at a consistent double-digit rate, helped by its leadership in bralettes. The brand grew its share of brick-and-mortar lingerie stores from 2.9 percent in 2015, to an estimated 3.1 percent in 2016, according to IBISWorld.

"They were early to [the trend] and they really own it," Chen said.

Victoria's Secret show dazzles, despite slow sales

Even as Victoria's Secret builds its credibility in these two newer product lines, there will be drawbacks. Namely, these easier-to-construct styles carry a lower starting price than their more dressed-up versions, meaning Victoria's Secret will have to sell larger quantities to hit the same sales figures.

This trend has been exacerbated by an influx of competitors in the space, which has led to price wars. During L Brands' fiscal third quarter, the lower cost of these items caused dollar sales in the bra category to decline, even as unit growth rose.

"This confirms our thesis that sales are being pressured from [the] mix," Jefferies analyst Randal Konik told investors at the time.

For its part, L Brands argues that bralettes are an incremental purchase, and a rise in volume should help make up for their lower ticket price. The company has also mentioned that the item has helped it attract a younger customer, which should help it drive future growth.

Yet for Konik, the lone analyst on TipRanks with a "sell" rating on L Brands' stock, Victoria's Secret's sultry image may be starting to miss the mark. He argues that as shoppers seek more natural looks — a trend that's reflected in the popularity of bralettes and a downturn in breast augmentation surgeries — Victoria's Secret's message is starting to grow stale.

The latest viewership figures from the brand's annual fashion show added fuel to his argument, as the brand turned in its all-time low rating among 18- to 49-year-old shoppers, he noted.

"We continue to believe the combination of emerging competition and a shift in the consumer mind-set towards more attainable beauty standards has driven a decline in interest in the Victoria's Secret brand," Konik told investors.

Though Cowen's Chen is not overly concerned with the label's branding, he did say the marketing may need to shift to stay relevant with millennial shoppers. One way of doing so could be playing up the brand's femininity, while promoting a sense of individualism.

"Being sexy has universal properties to it," Chen said.

From where Cohen sits, fears about the company's branding and place in the market are overblown. According to IBISWorld's data, Victoria's Secret accounts for a jaw-dropping 83.5 percent of total sales at U.S. bricks-and-mortar lingerie retailers — a number that continues to grow.

Even as competition rises among online-only players, she noted that Victoria's Secret is somewhat insulated from this trend, as lingerie shoppers tend to be more brand loyal. They also like having the option to try merchandise on in a store. Meanwhile, Chen said the company is still benefiting from decreasing market share among department stores.

"All of this kind of hubbub about Victoria's Secret being this dying brand, the numbers don't support it," Cohen said.

L Brands last month lowered its fourth-quarter earnings forecast from an implied $2 to $2.15 a share, to between $1.85 and $2 a share. That compares with a profit of $2.15 a share in the prior-year period.

Analysts expect the company's revenue to grow 4 percent, to $4.56 billion during the holiday quarter, according to a consensus estimate from Thomson Reuters.

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