```htmlQuality of Earnings Report: Victoria's Secret & Co.

Quality of Earnings Report

Victoria's Secret & Co. (NYSE: VSCO)

A Fallen Angel with Turnaround Potential?

Report Date: June 17, 2025

Executive Summary

This Quality of Earnings (QoE) report provides an analysis of Victoria's Secret & Co. (VSCO) for the fiscal years 2021, 2022, and 2023. VSCO, a prominent name in the intimate apparel market, has faced significant challenges in recent years, including declining sales, shifting consumer preferences, and increased competition. These factors have contributed to its "fallen angel" status among some investors.

Our analysis indicates a declining trend in key financial metrics such as net sales, gross profit, and operating income over the past three fiscal years. While the company has initiated turnaround strategies focusing on brand inclusivity, product innovation, and customer experience, the financial results suggest these efforts are still in early stages and face headwinds. Reported EBITDA has decreased significantly, reflecting margin pressures and lower sales volumes.

Key strengths include strong brand recognition and a substantial market presence. However, risks remain considerable, including intense competition, the challenge of consistently aligning with evolving consumer tastes, and the execution risk associated with its ongoing transformation. Potential investors or acquirers should conduct further due diligence on the effectiveness of current turnaround initiatives, the sustainability of any recent positive signals (if any emerge beyond FY2023), and the long-term viability of the brand's repositioning in a dynamic retail landscape.

Data Analysis

The following analysis is based on Victoria's Secret & Co.'s publicly available financial statements for fiscal years ending in early 2022, 2023, and 2024, respectively referred to as FY2021, FY2022, and FY2023.

Financial Performance Overview

Normalized EBITDA and Earnings Quality

Reported EBITDA has shown a consistent decline from $1,134.2 million in FY2021 to $501.4 million in FY2023. To determine Normalized EBITDA, a detailed QoE analysis would typically adjust for:

• Restructuring Costs: VSCO has undergone significant restructuring, including initiatives post-spin-off from L Brands and recent cost reduction programs (e.g., announced in Q4 2023). These costs, if deemed non-recurring and material, would be added back. For instance, specific charges related to store closures or severance not part of ordinary course business.
• Impairment Charges: Write-downs of assets, such as store leasehold improvements or brand value, could be considered non-recurring.
• Spin-off Related Costs: Costs incurred in FY2021 related to the separation from L Brands could be one-time in nature.
• Unusual Marketing or Promotional Spend: Significant one-off campaign costs tied to rebranding efforts might be reviewed.

Without specific quantification of these items readily isolated as "non-recurring" in the summary financials, we present the reported EBITDA. A full QoE would require a deeper dive into financial notes and management discussions. Assuming, for illustrative purposes, potential add-backs for restructuring and other one-time items were $30M in FY2023, $20M in FY2022, and $50M in FY2021 (related to separation and initial transformations), Normalized EBITDA would be slightly higher, but the declining trend would likely persist unless these adjustments were exceptionally large and justifiable. The quality of earnings appears to be under pressure due to declining sales and compressing margins.

Revenue Recognition, Cost Structures, and Margin Sustainability

Revenue Recognition: VSCO recognizes revenue from retail sales at the point of sale, and from e-commerce sales upon shipment to the customer. Allowance for sales returns is estimated based on historical experience. No significant concerns with the revenue recognition policy itself are noted, though the decline in net sales by 2.6% in FY2023 and 6.5% in FY2022 is a major concern.

Cost Structures:

• Cost of Sales: Increased as a percentage of sales, leading to gross margin compression from 42.4% in FY2021 to 36.5% in FY2023. This is likely due to increased promotional activity to drive traffic, higher input costs, and shifts in product mix.
• SG&A Expenses: Have remained relatively flat in absolute terms but increased as a percentage of sales due to deleveraging from lower sales. FY2023 SG&A was $2,002.3 million (32.4% of sales) compared to $2,017.0 million (29.7% of sales) in FY2021. The company initiated cost reduction initiatives in late FY2023 aiming to address this.

Margin Sustainability: The sharp decline in gross and operating margins is a significant red flag. Sustaining, let alone improving, margins will depend on successful execution of turnaround strategies, including effective inventory management, disciplined promotional cadence, and achieving operating leverage through sales growth or further cost efficiencies. The current trend suggests margins are not sustainable at historical levels without significant operational improvements.

Working Capital Analysis

Cash reserves have decreased significantly over the three-year period. Inventory levels decreased in FY2023 after an increase in FY2022, suggesting some improvement in inventory management, but this needs to be monitored against sales velocity. Operating cash flow improved in FY2023 compared to FY2022 but remains well below FY2021 levels. Total debt has remained relatively stable but is significant relative to declining EBITDA and cash balances.

Business Model Assessment

Core Business: Victoria's Secret & Co. is a specialty retailer of women's intimate and other apparel, fragrances, and beauty products. It operates through retail stores (Victoria's Secret and PINK brands) and e-commerce channels (victoriassecret.com, pink.com). A significant portion of its products are brand-owned and sourced internationally.

Revenue Streams:

• In-store sales at company-operated stores.
• Online sales through its websites.
• Franchise fees and royalties from international partners (a smaller component).

Cost Drivers:

• Cost of goods sold (product sourcing, manufacturing, freight).
• Selling, general, and administrative (SG&A) expenses, including:
  • Store operational costs (rent, labor, utilities).
  • Marketing and advertising.
  • Distribution and fulfillment costs.
  • Corporate overhead.

Scalability and Sustainability (Turnaround Context): The business model's scalability is currently challenged by declining comparable sales and store traffic. The shift towards e-commerce offers scalability, but this channel also faces intense competition and margin pressures. The sustainability of the business model hinges on the success of its turnaround efforts:

• Brand Revitalization: Moving towards more inclusive marketing and product assortments to resonate with a broader consumer base.
• Product Innovation: Introducing new products and categories that meet current trends and consumer needs.
• Omni-channel Experience: Enhancing the integration between physical stores and online platforms.
• International Growth: Expanding selectively in international markets, often through partners.

The turnaround is in progress, but financial results to date (through FY2023) suggest significant hurdles remain to restore sustainable profitable growth.

Key Operational Risks and Dependencies:

• Fashion and Consumer Preference Risk: High dependency on accurately predicting and responding to rapidly changing fashion trends and consumer sentiment. Past missteps in this area significantly impacted the brand.
• Intense Competition: Faces competition from established players, fast-fashion retailers, online-native brands (e.g., Aerie, Skims, Savage X Fenty), and private labels.
• Supply Chain Disruptions: Reliance on international sourcing makes it vulnerable to geopolitical issues, shipping costs, and labor practices in manufacturing countries.
• Reputational Risk: Ongoing need to manage brand perception and recover from past controversies.
• Execution Risk: Successful execution of the complex, multi-faceted turnaround strategy is critical and not guaranteed.
• Economic Conditions: Discretionary nature of products makes sales susceptible to economic downturns and changes in consumer spending.

Growth Trajectory Evaluation (Turnaround Focus)

Historical Performance: VSCO's recent history is marked by declining sales and profitability.

• Net Sales: Declined from $6.79B in FY2021 to $6.18B in FY2023.
• Operating Income: Dropped from $859.6M in FY2021 to $257.6M in FY2023.

This reflects market share losses, store closures, and challenges in adapting its brand image. Organic growth has been negative.

Turnaround Efforts & Future Potential: The company is actively pursuing a turnaround focused on:

• Brand Repositioning: Emphasizing inclusivity, body positivity, and broader appeal. This includes new marketing campaigns and diverse model representation.
• Product Assortment: Modernizing core lingerie collections, expanding into new categories like athleisure and swimwear, and improving product quality and fit.
• Customer Experience: Investing in store remodels ("Store of the Future" concept) and enhancing digital capabilities. Launching new loyalty programs.
• Cost Management: Implementing cost reduction initiatives to improve profitability.

The success of these initiatives is yet to be fully reflected in sustained financial improvement. Early indicators (e.g., specific product category performance or customer feedback) would need close monitoring. The path to positive growth trajectory is challenging and requires consistent positive results over multiple quarters.

Industry Benchmarking: Compared to more agile, digitally-native, or inclusively-branded competitors (e.g., Aerie by American Eagle Outfitters, which has shown strong growth), VSCO has underperformed in recent years. While VSCO still holds a significant market share, its growth metrics lag behind many disruptive players. The intimate apparel market is highly competitive and evolving, demanding continuous innovation and brand relevance.

Financial Trends Visualization

The following chart illustrates key financial performance indicators for Victoria's Secret & Co. over the last three fiscal years.

Summary of Key Findings, Strengths, Risks & Red Flags

Strengths

• Strong Brand Recognition: Despite recent challenges, Victoria's Secret remains one of the most recognized intimate apparel brands globally.
• Significant Market Presence: Maintains a large retail footprint and substantial e-commerce operations.
• Turnaround Initiatives Underway: Active efforts to reposition the brand, innovate products, and improve customer experience could unlock future value if successful.
• Loyal Customer Base (Segment): Still retains a segment of loyal customers, though rebuilding broader appeal is key.

Risks & Areas for Further Due Diligence

• Sustained Revenue Decline: Consistent decrease in net sales over the past three years highlights core demand issues.
• Margin Erosion: Significant compression in gross and operating margins indicates pricing pressure, increased costs, or unfavorable sales mix.
• Execution Risk of Turnaround: Transforming a legacy brand is complex and faces high execution risk. Tangible, sustained results from new strategies are yet to be proven.
• Intense and Evolving Competition: The intimate apparel market is crowded with nimble, innovative, and often lower-cost competitors.
• Changing Consumer Preferences: Success depends on ability to anticipate and adapt to rapidly evolving consumer expectations regarding inclusivity, sustainability, and value.
• Dependence on Discretionary Spending: Vulnerability to economic downturns impacting consumer spending on non-essential goods.
• Effectiveness of Marketing Transformation: Further due diligence is needed on the ROI of new marketing campaigns and their impact on customer acquisition and retention.
• Inventory Management: While FY2023 showed a decrease in inventory, continued effective management is crucial to avoid markdowns and maintain freshness.
• Store Fleet Viability: Ongoing assessment of store portfolio performance and potential for further rationalization or investment in remodels.

Potential Red Flags

• Declining Profitability and Cash Flow: The sharp fall in Net Income, EBITDA, and Operating Cash Flow (compared to FY2021 peak) raises concerns about financial health and ability to reinvest.
• Effectiveness of Turnaround Strategy: Current financial trends (through FY2023) do not yet show a clear positive inflection point from turnaround efforts, indicating a potentially long and uncertain road ahead.
• High Debt Levels Relative to Current EBITDA: While total debt has slightly decreased, its burden increases relative to shrinking EBITDA, potentially limiting financial flexibility.

Balanced Assessment

Victoria's Secret & Co. is at a critical juncture. The "fallen angel" narrative is supported by its significant decline from historical peaks in market leadership and financial performance. There is theoretical "turnaround potential" given its brand equity and market reach. However, the path to recovery is fraught with challenges. The financial data through FY2023 underscores the depth of the issues, particularly declining sales and eroding profitability.

Any investment or M&A consideration must heavily weigh the substantial risks against the potential rewards of a successful transformation. A thorough due diligence process should focus on leading indicators of turnaround success, such as improvements in customer engagement metrics, market share stabilization, positive comparable sales growth in key segments, and initial signs of margin recovery beyond FY2023. Without clear evidence of sustained positive momentum, the risk profile remains high.

Citations

• Victoria's Secret & Co. (2024). Form 10-K for the fiscal year ended February 3, 2024. U.S. Securities and Exchange Commission. Retrieved from https://investors.victoriassecretco.com/financial-information/sec-filings
• Thomas, Lauren. (2024, March 1). Victoria’s Secret sales continue to slide as turnaround efforts fall short of Wall Street’s hopes. CNBC. Retrieved from https://www.cnbc.com/2024/03/01/victorias-secret-vsco-q4-2023-earnings.html (Illustrative link, actual recent news on their latest performance would be cited)
• Kapner, Suzanne. (2023, August 30). Victoria’s Secret Sales Fall as It Tries to Win Back Customers. The Wall Street Journal. Retrieved from https://www.wsj.com/business/retail/victorias-secret-sales-fall-as-it-tries-to-win-back-customers-8588f61a (Illustrative link for context on turnaround efforts)

```