Bath & Body Works

Bath & Body Works' second-quarter sales fell 2.3% to $1.5 billion, beating guidance for a 3%-5% decline. Adjusted diluted EPS of $0.62 exceeded the $0.20-$0.25 outlook, aided by $80 million in tariff refunds, which will offset ongoing trade pressures and fund strategic investments in the back half.

Why it matters: Despite pressured consumers, the Consumer First Formula is showing early signs of success, with sequential improvement in body care and digital sales returning to growth (up 3%). We view management's focus on innovation and adaptation to consumer demands as prudent. Fruit Fusion highlights BBW's innovation efforts, delivering higher average unit retail than core products while its campaign generated 615 million impressions. Management is using insights from the launch to shape future scents and forms for the line, which we think should support consumer engagement. Beyond innovation, BBW is catering to evolving consumer preferences. The firm exited homecare (less than 1% of annual sales), citing high operational complexity and weak demand. We believe this reflects disciplined capital allocation, supporting the potential for better ROICs.

The bottom line: We plan no material change to our $54 fair value estimate for no-moat Bath & Body Works. Shares are up 7% midday on Aug. 26, but we still view them as undervalued as investor impatience outweighs growth that is unlikely to surface until 2027. BBW raised fiscal 2026 adjusted EPS guidance to $2.60-$2.80 (from $2.40-$2.65), with $0.31 due to tariff refunds, and narrowed its sales growth outlook to down 4%-2.5% (from down 4.5%-2.5%). We expect innovation and consumer engagement efforts to drive greater benefits ahead. The firm exceeded its 2026 Fuel for Growth savings target by $25 million, lifting total savings to $200 million. Ongoing efficiencies should fund brand investments and support margin expansion, underpinning our 18% midcycle operating margin forecast, constrained by elevated competition.

We think Bath & Body Works' test-and-learn approach to product launches and adjacent categories is wise, as it allows the firm to pursue growth opportunities with limited capital at risk. Management has shown a willingness to expand into categories that complement its core portfolio while maintaining the discipline to exit areas that fail to resonate with consumers. We have seen this play out repeatedly, including with men's grooming and haircare last year and bar soap, which returned in 2022. In our view, this approach reflects the firm's flexibility and responsiveness to evolving consumer preferences. By letting consumer feedback guide investment decisions and determine which concepts are scaled, Bath & Body Works can allocate resources more effectively, strengthen product relevance, and deepen consumer engagement over time.

We are maintaining our fair value estimate of $54 per share as updated fiscal 2026 guidance did not materially change our forecast for the year. Second-quarter sales fell 2.3% to $1.5 billion and adjusted earnings per share nearly doubled to $0.62, helped by $80 million in tariff refunds ($0.31 impact). Operating margin rose 420 basis points to 14.3%, helped by the same factors and incremental expense savings. Several positive indicators of the Consumer First Formula were evident as body care exhibited sequential improvement and digital sales returned to growth for the first time since 2021 (up 3%). The firm narrowed its full-year outlook for a sales decline of 4.0%-2.5% and raised its adjusted EPS guidance to $2.60-$2.80 from $2.40-$2.65.

The composition of 2026's adjusted EPS stems from gross margin and selling, general, and administrative cost margin declines to 43.3% (from 42.2%) and 29.6% (from 29.2%), respectively, largely driven by product investments and incremental tariffs. These expenses will not be able to be fully offset by the $250 million Fuel for Growth cost-saving initiative (though $200 million have already surfaced in the current year, ahead of the $175 million goal). Our forecast includes sales that decline 3% (from 2.9% prior), adjusted operating margin of 13.7% (13.4% prior), and adjusted EPS of $2.78 ($2.63).

Bath & Body Works is relying on strategic initiatives under the Consumer First Formula initiative to return the company to growth, focused on restoring power to its core product lines, elevating tactical marketing, improving distribution, and extracting efficiencies from the business. These efforts underlie our long-term projected sales growth, which we have predicated on three channels. First, 2.5% average long-term growth from the store channel (77% of 2025 sales). Second, 4% average digital growth, bound by levels of digital growth BBW has already captured in recent periods (with digital representing 19% of sales in 2025) and the likelihood that digital as a percentage of the total sales mix should normalize at 22% over the next decade. Third, we forecast international growth could rise at 7% longer term as global franchise partnerships expand.

The scope of opportunities gives us confidence in our forecast, with the firm seeking to capitalize on new store formats (continued omnichannel expansion), an updated loyalty program, and new categories (like men's and lip), among others. As covid threats remain depressed, consumers could continue to allocate spending to discretionary categories they had held back on (dining, travel), which is a key risk to our outlook. Even with more controlled growth ahead, we still forecast that BBW will generate ROICs excluding goodwill that average 35% over the next decade.

Despite current challenges, we still view the shares as attractive, as we believe cost inflation and consumer apprehension will normalize over time, allowing BBW to approach an improved long-term profit algorithm. BBW has previously stood firm on a 20% operating margin goal, and it is testing pricing mechanisms on products and pursuing a $250 million cost-saving plan that should help steer the business back to around 17.4% operating margin performance by 2030.

Our Morningstar Economic Moat Rating for Bath & Body Works is none, reflecting concerns that increasing competition has made consistent sales growth and margin expansion more difficult, as demonstrated over the past three years. Management estimates that gross margin leverage requires 2%-3% sales growth and selling, general, and administrative leverage 2.5%-3.5%, both only modestly above our long-term sales growth forecast of 3%, leaving limited room for consistent margin expansion. However, we think it will likely be easier to leverage operating expenses than to raise prices going forward.

While BBW is a leader in specialty home fragrance (40% of sales), body care (40%), and hand soaps (15%), these categories are niche and highly competitive. Its share of the North American bath and shower market has declined to 10.3% in 2025 from 14.2% in 2021, including a 420-basis-point drop in body wash and shower gel, while peers such as Dove and Olay have held or gained share. BBW modestly trails Yankee Candle’s share in the candle and air freshener category, which has faced secular headwinds, trending down at more than 3% annually over the last five years. This market share erosion suggests BBW lacks a durable competitive advantage, weakening the case for a brand-based intangible asset moat.

BBW’s brand has shown some pricing power, as seen by its ability to charge more per ounce than peers for certain items. For example, its foaming hand soaps sell for $0.91 per ounce versus $0.43 for Mrs. Meyer’s and $0.35 for Dial. In body lotion, the firm commands a price of about $2.12 per ounce compared with Olay’s $0.70. However, the need to discount in recent years to drive sales has led to profit compression (operating margin fell to 16% in 2025 from 26% in 2021). We see this as proof that switching costs are low and that some consumers fail to see products as differentiated enough to warrant perpetual premiums.

BBW’s weakening product resonance is reflected in sales per square foot that have fallen about 4% annually since 2021, despite remaining above $1,000 in 2025. This decline is notable given the firm's shift toward higher-performing off-mall locations, which now account for about 60% of stores and typically generate stronger conversion rates than traditional malls. We expect the Consumer First Formula and continued portfolio optimization to drive a modest improvement in store productivity.

The Consumer First Formula aims to restore sales and profit growth through product innovation, brand elevation, expanded distribution, and cost efficiencies. Despite BBW’s strong inventory turns (5.8 times on average over the past five years), we do not expect sales growth to turn positive until 2027. Even if execution takes longer than anticipated, we think the firm can maintain double-digit operating margins, albeit below historical levels, as it invests to remain competitive. Marketing spending has averaged 3% of sales over the past five years, broadly in line with peers such as narrow-moat Ulta (3.9%), and we expect investment to remain near this level to support brand awareness.

We view the Consumer First Formula as an effort to institutionalize best practices while reinforcing BBW’s core categories of body care, home fragrance, and soaps and sanitizers, along with iconic fragrances like Japanese Cherry Blossom. Rather than limiting growth opportunities, this strategy prioritizes innovation in scents, packaging, and formulations to improve returns. As part of this focus, BBW is reducing exposure to less productive adjacencies, having cut roughly 10% of SKUs while leveraging collaborations such as Disney Princesses to drive customer engagement.

The strategy also seeks to improve product reach through select marketplace and wholesale expansion, including the launch of an Amazon storefront. We view this as a prudent move, given management's estimate that third-party sellers were previously generating $60 million-$80 million in annual Amazon sales. A branded storefront should help BBW recapture these sales, strengthen merchandising and brand presentation, and attract new customers. The plan also targets $250 million in cost savings, representing less than 5% of the cost base and unlikely to constrain brand investment. Even so, we forecast operating margins recovering to just under 18%, below the 20%-plus levels achieved in 2021 and for much of the prior decade.

We model modest success from the Consumer First Formula, resulting in average ROIC, including goodwill, of 35% over the next decade versus 28% over the past five years. While well above the firm's 8% weighted average cost of capital and many peers, we believe these returns partly reflect BBW's asset-light business model, which benefits from a fairly low invested-capital base.

We view BBW’s international opportunity as attractive but unlikely to exceed 10% of sales, up from 4% in 2025, making it a limited driver of moat restoration. The firm adapts assortments to local preferences, helping broaden its appeal across markets. While BBW ranks fourth in the fragmented global bath and shower market (behind wide-moat Unilever’s Dove and Lux and wide-moat Colgate-Palmolive’s Palmolive) and holds 23.8% of the global candle air freshener market (second to Yankee Candle at 32.1%), we still see pervasive competition across these categories, limiting consumer stickiness.

While BBW benefits from strong brand awareness and a responsive supply chain, we do not believe it has a cost advantage. Through Beauty Park, a network of suppliers and manufacturing partners near its Ohio headquarters, the firm effectively replicates a vertically integrated model that enables rapid responses to consumer demand. While this ecosystem is difficult to replicate, rising costs have pressured its economics in recent years. Moreover, despite sourcing roughly 80% of products domestically, BBW remains exposed to tariffs, which reduced gross margin by 110 basis points in 2025.

BBW is set to renegotiate leases over time. Favorably updated rent agreements, new off-mall locations, and productivity gains from updated format conversions could help boost profits.

The firm has a robust customer loyalty app; at last disclosure, it has attracted 40 million active members that make up more than 80% of US sales. This should support repeat customer sales growth.

The Consumer First Formula strategy could improve sales faster than we expect. If the firm finds incremental savings to its $250 million Fuel for Growth cost initiative, expense leverage may accelerate.

A downshift in demand around mall retailing could further slow foot traffic, tempering demand. Mall locations still represented about 40% of the fleet at the end of fiscal 2025 (versus 61% in 2016).

Consumer trends can change rapidly, leading to a mismatch in customer assortment and demand. This could take time to remedy and temporarily hinder profits if BBW has to discount to clear inventory.

As covid risks remain minimal, consumers could further shift discretionary spending from soaps and sanitizers to other categories, ceding additional volume benefits to the operating margin.