Victoria's Secret could use a little lift

NEW YORK ( Fortune) -- Like a supermodel past her prime, Victoria's Secret is showing its age.

The company, which did for lingerie what the Wonderbra did for cleavage, is facing an onslaught of new competition at a time when its strategy of store expansion and high-octane advertising looks tired.

Even the company's marketing juggernaut, the orgy of flesh that is its annual fashion show, which takes place Thursday night and will be broadcast Dec. 4 on CBS, is losing steam.

"In many ways, Victoria's Secret is a victim of its own success," said Paul Lejuez of Credit Suisse First Boston. "They've created this lucrative business that a lot of people are chasing after."

Kohl's, Target (Charts, Fortune 500), J.C. Penney, Bloomingdale's, Nordstrom (Charts, Fortune 500), American Eagle Outfitters, Chico's FAS and Lane Bryant are just some of the retailers that have added new lingerie lines or updated existing offerings by renovating dressing rooms and adding special services like bra fitters, moves that are stealing Victoria's Secret's thunder.

The heightened competition is a change from the prior two decades, when Victoria's Secret largely had the market to itself.

When the Columbus, Ohio-based Limited Brands (Charts, Fortune 500) acquired several Victoria's Secret stores in 1982, women tended to own a handful of bras and panties in plain vanilla colors like white and beige. Limited CEO Les Wexner predicted women would buy underwear as frequently as they bought clothes if there were more styles and colors to choose from. He had Victoria's Secret create a kaleidoscope of looks that were sexy enough to tempt shoppers - but not too racy for the masses.

Victoria's Secret now accounts for the lion's share of Limited's business, making up slightly more than half of the company's $10.7 billion in sales and two-thirds of profits. Second quarter earnings for Limited were cut into by a 14 percent decline in Victoria's Secret's operating profit, and analysts expect Limited to break even when it reports third quarter results on Tuesday.

The company's troubles come as overall U.S. sales of intimate apparel start to slow. For the nine months ended September, sales of intimate apparel totaled $8 billion, up a scant 1.6 percent from the year earlier period. That compares with growth of nearly 8 percent for the 2006 January to September period, according to the NPD Group.

To defend its turf, Victoria's Secret is rolling out several new initiatives, including the launch of new products that go beyond lingerie and an aggressive expansion of its store base.

The company plans to introduce accessories such as luggage tags, wallets and passport holders this holiday season and is already testing athletic apparel.

The additional products will be showcased in larger stores. Victoria's Secret plans to increase the square footage of as many as 140 locations by 50 percent this year. Ultimately, some 700 stores out of a total of 1000 could be expanded.

Analysts said the plan is risky, coming at a time when sales at Victoria's Secret stores open at least a year are slowing. For the most recent quarter, same-store sales increased 3 percent, down from 10 percent growth in the year-earlier period.

"I'm concerned that Victoria's Secret is increasing capital expenditures at a time when traffic at its stores is declining," said Morgan Stanley analyst Michelle Clark.

Clark predicts the move to expand stores will depress the company's sales per square foot, since new and enlarged stores initially tend to be less productive than older locations. Clark expects sales per square foot to fall to $689 this year, down from a high of $731 in 2006. Although sales per square foot should start to rebound slightly in 2008, she does not expect them to recover to last year's level anytime soon.

Victoria's Secret spokeswoman Tammy Roberts Myers said in an email that the company is pleased with the early results of its store expansion strategy. She added that Victoria's Secret is aware of the heightened competition, but has moved to differentiate itself. "We're really more of a lifestyle brand than simply a lingerie and personal care [retailer]" she said.

Over the years, Victoria's Secret has been masterful at generating buzz through the use of supermodels in its advertising and with its annual fashion show.

But as advertising has become more viral and migrated to the Web and as celebrities have replaced supermodels as the new style setters, Victoria's Secret's strategy has begun to look dated, observers said. Ratings for the televised show dipped last year to 4.8 percent, down from 8.2 percent in 2002, according to Nielsen.

Roberts Myers said the fashion show has grown beyond the one-hour catwalk and subsequent TV broadcast, and so ratings are not the best measure of its success. The event garners the company valuable coverage on Entertainment Tonight and Access Hollywood among other programs.

This year, Victoria's Secret is partnering with Virgin America, which will host a pajama party during a commercial flight on Nov. 28, in which paying ticket holders can mingle with the supermodels.

That should help Victoria's Secret look glamorous from 35,000 feet. But on the ground, the company is still struggling.