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The following is an excerpt from the February issue of The Strategist Newsletter. It has been submitted to Seeking Alpha as a sample of our product outside of the commodity and rare earth space in which the majority of our Seeking Alpha contributions have been concentrated.

This is a follow up to a previous newsletter article in which we laid out our qualitative and quantitative thesis in Limited Brands in great detail. The goal of this article is to share our "back of a cocktail napkin" valuation model on Limited Brands.

Despite a poor start to 2011, we see excellent value in Limited Brands (LTD) going forward and view the pullback as a consolidation in the context of a long term uptrend.

Limited Brands is a company with six core brands, the primary three of which are Victoria's Secret, Pink, and Bath & Body Works.

The company announced this past week it is raising its regular dividend to $0.80/share per annum. We believe that the management target of 15% margins is very achievable and see an excellent long term story for the stock. With the opening of the flagship Victoria's Secret store in London 2012, Limited Brands will begin an international expansion of a premier retail brand.

The Limited Brands investment thesis consists of two stages. Before the international growth component of the Limited Brands story comes the efficiency story, in that management is looking to achieve 15% operating margins. The management team has been together for a while and our faith in them is based in part on their excellent execution in the 2009-2010 time frame, which has been reflected in the stock rallying from $6 in March 2009 to the mid-thirties in late 2010.

Model Assumptions: With earnings due at the end of February, we do not have an official 2010 sales figure, so we are working with three sell side estimates that all are closely around $9.5 billion, which we will use as our 2010 sales figure.

We also are assuming a 14% operating margin in 2011,15% in 2012, and then a constant 16% operating margin in 2013 going forward, as international sales and Victoria's Secret Direct add increased leverage beyond the original 15% operating margin target.

We have assumed sales growth at 5% per annum through 2015 as representative of economic growth and the international expansion efforts.

We have also assumed $350 million in depreciation annually with $300 million in CAPEX.

We assumed no share buybacks while we do believe they will actually occur.
Our very simplified model of Limited Brands suggests a fair value of $38-40/share at the current time which we derived by averaging the Net Present Values from an 8% and a 10% discount rate.


On a P/E basis, we can see $45/share in the next two years, as the earnings per share of Limited Brands exceeds $3/share based on a market multiple of 15x.

In the past year, Limited Brands has declared two special dividends. We expect special dividends will continue as a way to return excess cash to shareholders. Management has a cash target of $600 million (source: Morgan Stanley research report), and we think they will continue to utilize the special dividend mechanism.

As a final point, we would like to preemptively point out that Limited Brands has very little exposure to cotton as an input cost, so it is insulated from increased cotton prices versus its competitors in the apparel and retail sector.

We like Limited Brands as a core long portfolio position. It is the largest position in our editor's personal portfolio and it is in The Strategist Paper Portfolio.

Disclosure: I am long LTD.

Additional disclosure: The facts in this newsletter are believed by the Strategist to be accurate, but the Strategist cannot guarantee that they are. Nothing in this newsletter should be taken as a solicitation to purchase or sell securities. These are Mr. Evensen’s opinions and he may be wrong. Principals, Editors, Writers, and Associates of The Strategist may have positions in securities mentioned in this newsletter. You should take this into consideration before acting on any advice given in this newsletter.
Source: Limited Brands: Plenty of Upside, We See Fair Value of $40/Share