Bath and Body Works Category Expansions Offer Total Addressable Market Growth

Senior Equity Analyst

Jaime M. Katz

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We believe Bath & Body Works has carved out a solid competitive edge in the sizable addressable markets in which it operates. The company’s strong brand intangible asset is supported by its leadership position across the bath and shower and candle air freshener industries in recent years, which has been bolstered by BBW’s quick response to consumer trends. Quantitatively, the narrow moat is reinforced by a 54% average return on invested capital excluding goodwill that we expect the business to generate over the next decade, well ahead of our 8% weighted average cost of capital estimate.

We think the $71 billion bath, body, and beauty industry, $11 billion home fragrance market, and $5 billion soap and sanitizer market still offer a plethora of upside over the long term relative to BBW’s 2022 sales of $7.6 billion. The firm has outlined a compelling pipeline of opportunities across existing and adjacent categories to reach new consumers and stimulate higher sales conversion ahead. For example, not only can BBW add expansion products like shaving and facial care, but it can also expand its penetration in categories like haircare, men's care (most recently with grooming), and laundry.

This robust pipeline of opportunities should support average sales growth of 3% over fiscal 2023-27. We forecast sales of $8.8 billion in 2027, which is contingent on average sales growth of 1.4% from North American stores, 5% from the digital channel, and 12% from international opportunities. This should be supported by elevated engagement with the brand, as there is more than 80% brand awareness of women 18-59 years old (and 60% of men in the same cohort). Longer term, operating margins should return to the low 20s (from a inflation-ravaged 17% estimated rate in 2023) as the firm's cost structure normalizes. Furthermore, while post-coronavirus consumer spending could continue to center around categories like travel, BBW should see solid demand trends ahead, with our forecast for organic growth in line with the roughly 4% growth projection (Euromonitor) for the domestic beauty and personal care industry during 2023-27. This growth could be faster with new line extensions.

Business Strategy & Outlook

Bath & Body Works is the number-one specialty home fragrance (40% of sales), body care and fragrance (35%), and hand soap and hand sanitizer (20%) vendor in America, with brand visibility supported by its more than 1,800 locations. With these three market-leading categories constituting around 95% of BBW’s total sales, we believe it signals the product offerings’ strong resonance with the firm’s consumer base. According to Euromonitor, BBW holds the second spot in the more than $10 billion domestic mass bath and shower business (behind wide-moat Unilever), with share growing from 12% in 2013 to 14% in 2022, and more than double the share of number-three player Dial (owned by narrow-moat Henkel). In the $2.2 billion candle air freshener category, BBW held an impressive 32% share in 2022, up from 22% in 2013, second only to Yankee Candle (42%, a Newell brand) and around triple the next competitor’s (Glade, owned by S.C. Johnson) market share. In skincare, BBW has realized slow but positive market share gains, as it held 3.5% share in 2022, up from 3.4% in 2013. Given the intense competition and fragmented nature of the skincare industry, we view this steadfast position as evidencing the company’s solid brand intangible asset; BBW holds the third-largest market share after Neutrogena (4.5%, a wide-moat Johnson & Johnson brand) and CeraVe (5.8%, owned by wide-moat L'Oreal) and Olay (owned by wide-moat Procter & Gamble). Overall, Bath & Body Works has demonstrated its ability to maintain or gain market standing independent of external conditions (particularly in the bath and shower and candle businesses), which indicates a brand intangible asset exists.

The perpetual introduction of unique product offerings, with floor sets rotating every four to six weeks on average, has also helped BBW post consistent financial performance over the last decade, and we contend this has led to these solid market share positions. For example, sales grew to $7.6 billion in 2022 from $2.6 billion in 2010, while the net store base growth was up just 8% in locations over the same time frame. But beyond the nearly 300% increase in sales over this time frame, such robust demand has allowed for the continued extraction of operating gains from the model, evidenced by an operating margin of 18% in 2022. We believe consistency in historical margins (above 20%, but which have recently been temporarily eroded by inflation) stems from the pricing power of the business, which generated 41% average gross margins in 2018-22, ahead of the mid-30s that beauty retailer Ulta and specialty retailer Williams-Sonoma (both with narrow moats) were able to capture over the same time frame. As evidence, while BBW shower gel prices around $13.50 (and above) per 10-ounce bottle, Dove clocks in around $7 for 22 ounces and Dial at less than $5 for 21 ounces. Even with a buy one/get one free or a buy one/get two free promotion, BBW is handily outpacing its peers on a price/ounce basis. All in, we believe such factors demonstrate the consumer resonance of the offering, and as such, we believe BBW warrants a narrow economic moat rating. 

Part of BBW’s productivity gains can be quantified via improving average sales per square foot—a particular bright point, given the struggles other mall retailers have faced in recent years in stimulating foot traffic. Sales per square foot clocked in at around $1,200 in 2022, handily outperforming numerous retailers with similar geographic exposure. For reference, narrow-moat Nordstrom has recently pulled in more than $400 per square foot, with most other department store-type retailers (Kohl’s, Macy’s, JC Penney) around $200 per square foot, metrics which have become difficult to parse as omnichannel sales have become pervasive). Those consumer retailers that have aligned with or surpassed BBW’s sales per square foot have generally been significant market leaders (narrow-moat Apple), those that have a particularly small footprint (Warby Parker), or firms that are considered luxury brands (Tiffany, narrow-moat Lululemon).

Additionally, we contend that part of BBW’s robust productivity metrics are a result of the company’s ability to perpetually adjust its retail footprint to incorporate higher-performing locations into the mix. While around one quarter of the store fleet is in Class A or -B malls, around 50% of locations were in specialty, strip malls, and other types of real estate, where conversion is often higher. When consumers visit an off-mall location, it tends to be with purpose and intent, rather than to just peruse (like those walking through a mall might do). Given the higher productivity of these locations, we expect BBW to accelerate its focus on off-mall boxes. The brand had around one quarter of its boxes in weaker demographic Class C and -D malls. With Class D units seeing shorter average lease terms (two to three years), BBW should be able to continue to adjust the footprint of its fleet in order to maximize four-wall productivity. Furthermore, we think flat shipping costs and in-store-only offerings should entice consumers to shop BBW’s physical boxes, supporting traffic and ticket growth while bounding the shift to e-commerce relative to other retailers (e-commerce represented 23% of 2022 sales).

With a proven blueprint to follow and continued spending on product innovation, BBW’s sales should be able to modestly outpace market growth ahead (beyond the 3% dip we forecast for 2023), supporting continued brand equity. Euromonitor projects around 4% beauty and personal care growth domestically between 2023-27. Our sales forecast over the same time frame for BBW averages 3.2%, disproportionately affected by an 3% decline in 2023. However, over the remainder of our forecast, BBW’s sales growth should still outpace the industry, even with 2% growth at stores, 6% growth from digital, and 12% growth from the international segment incorporated (driving a 4% average top-line opportunity over the next decade). 

Quantitatively, robust ROIC forecasts also support our narrow moat rating. Over the next decade, BBW should be able to generate ROICs excluding goodwill that average 54%, well above numerous other consumer companies, thanks to the low working capital base and the fast cash-conversion cycle (four to five weeks). For reference, even luxury companies like Nordstrom and wide-moat Richemont (which have low capital intensity) are set to generate average ROICs including goodwill between 10%-20% through 2027. On the luxury beauty/personal care side, wide-moat Estee Lauder is set to generate ROICs excluding goodwill that average 18% over the next five years, a level we believe the BBW business should surpass, offering us further evidence that BBW has a brand intangible asset edge.

Narrow

Economic Moat

Bath and Body Works

Bath & Body Works, Inc. is a specialty retailers and home to America’s Favorite Fragrances, offering a breadth of exclusive fragrances for the body and home, including the selling collections for fine fragrance mist, body lotion and body cream, 3-wick candles, home fragrance diffusers and liquid hand soap. The company was founded by Leslie Herbert Wexner in 1963 and is headquartered in Columbus, OH.

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