BURL - Burlington Stores: 5-Year Growth Outlook Is Achievable (Rating Upgrade)

2023-12-27 10:01:36 ET

Summary

• I am revising my rating from hold to buy.
• BURL saw sales growth of 12.2% in 3Q23, outperforming peers TJX and Ross Store.
• The company's 5-year guidance suggests positive growth potential, with expectations of revenue reaching $16 billion in CY2028.

Investment action

I recommended a hold rating for Burlington Stores (BURL) when I wrote about it the last time , as I did not see any positive catalysts that would drive multiples upward. My expectation was that the stock price would stay rangebound. The stock clearly did not stay rangebound, as it took a dive from ~$160 to ~$115 before rebounding to $191 after the 3Q23 earnings. Based on my current outlook and analysis of BURL, I recommend a buy rating. My outlook for comparable store sales and net new store growth is positive based on today's outlook. As such, I believe there is a good potential for BURL to meet its 5-year guidance, which calls for ~$16 billion in revenue in FY28, which implies an 11% growth CAGR.

Review

In 3Q23 , BURL saw sales growth of 12.2%, driven by comparable store sales growth of 6% and the balance by unit growth. While a gross margin of 43.2% came in lower than consensus expectations, the business did see 150 bps of merchandise margin expansion and ~50 bps of freight cost improvements. These expansions were, however, partially offset by an increase in SG&A as a percentage of sales, hence leading to an EBIT margin of 4.4%, just 10bps shy of meeting consensus estimates.

Remember when I said that BURL needs to show that it can outperform peers (TJX (TJX) and Ross Stores (ROST)) before the market will drive valuations upward? BURL delivered well on this, as it did much better in 3Q23. TJX saw a 3Q revenue growth of 9%, while ROST saw a 7.9% growth. The positive share price reaction after the 3Q23 earnings was a validation that the market was looking for BURL to outperform, and I believe the current growth strength can continue through 4Q23 and FY24. With November off to a strong start thanks to cooler weather, and management expressing confidence in the company's positioning heading into the holiday season, the growth outlook for the near term, 4Q23, is very positive. In addition, BURL is going to benefit from Christmas falling on Monday this year, as families have more time to go shopping outside (vs. last year, which fell on a weekend; hence, there was no additional public holiday). As for FY24, I expect growth to remain strong as I expect the economy to start turning for the better. While I am not a macro expert, I take the fact that the Fed is looking to cut rates as a positive signal that the economy is seeing signs of normalization, and 2024 could be the year of recovery. The fact that low-income consumers' health is improving is consistent with this view.

"The first is that the lower income customer, who was really struggling in 2022, has stabilized and is even starting to show some signs of improvement." 3Q23 call

As the economy and the financial health of BURL's targeted consumer base recover, I think there is a good chance for BURL to hit its long-term guidance (provided in 3Q23 earnings). At a high level, management is guiding $16 billion in sales and $1.6 billion in EBIT by CY28. This translates to about 11% CAGR from LTM revenue of $9.34 billion and a 10% exit EBIT margin. Breaking down the growth equation:

1. Management expects to open 500 net new stores over 5 years, which translates to 100 net new stores a year and 25 per quarter. I point to three data points that suggest BURL can grow the number of units as planned. Firstly, over the past 5 years, BURL has opened an average of 23 net new stores per quarter, despite the COVID period, which has depressed growth opportunities. As the economy recovers, BURL should be in a better position to open more than 23 stores per quarter. Secondly, BURL is still largely underpenetrated relative to TJX. As of 3Q23, TJX has a total of 4,934 stores across the US, while BURL only has 977. There is a clear precedent that suggests BURL can continue to expand its footprint. Thirdly, management noted that the 2024 store plan is going as planned and the new store pipeline beyond 2024 is healthy.
2. Management expects comparable store sales to grow by more than 5% over the 5-year period. Similar to the store growth expectations, I believe this is possible as well. I don't think the past few years are a good representative of BURL's comp sales growth, as it was heavily impacted by COVID. If we look at BURL's pre-covid performance, it has average comp sales of about 3.5%. Suppose the economy goes back to normalcy. I expect BURL to revert back to this 3.5%; as such, the delta vs. management 5-year guide is 150bps. This 150 bps should be easily achievable given the 2.0 off-price improvements, new store, and relocation programs (which I see as a growth tailwind as new stores are generally in better and busier centers).

As for the EBIT margin of 10%, I have less confidence in this target as of today, given that a lot of the improvements are exposed to execution risk. Specifically, the 10% EBIT margin calls for 400bps of EBIT margin expansion over the next 5 years (using the consensus FY24 EBIT margin estimate of ~6% as the base). Of the 400 bps, 200 bps is going to come from company-specific savings, driven by lower markdowns, freight expenses, and lower supply chain expenses. I would not undermine management's strategy here, but I am staying cautious with regard to lower markdowns and supply chain expenses (e.g., more automation) as to how successful they can be, as these should be things that BURL has been consistently aiming to improve. The other 200bps comes largely from sales leverage, which I think has a high chance of coming true given the growth outlook for BURL. Net-net, for EBIT margin expansion this is not impossible, but I am not confident enough to assume a full 400 bps expansion based on today's data.

Valuation

I am revising the way I model BURL to be based on its 5-year outlook. As I discussed above, I think BURL has strong potential to grow as guided (~11% CAGR) over the next five years until FY28. This would bring BURL revenue to a size of ~$16 billion in FY28. As for EBIT margin, I am less positive about whether BURL can achieve its 400bps expansion (from FY24/CY23). My assumption is that BURL is only going to be able to expand margin by 200bps as it benefits from sales leverage (I am more confident about the growth outlook). If the EBIT margin does expand by 400bps in total, that would be great, but I am not placing my bets on that. As BURL shows the expected growth strength, I would think it is safe to assume it should trade at least in line with its historical average. Historically, BURL trades at 21x forward EBIT, and I am taking the more conservative approach to assume it will trade at 21x forward EBIT in FY27. However, I note that a higher multiple could be justified given the improved growth outlook (BURL usually grows in the high single-digit percentage).

Risk and final thoughts

Given that the focus is on the 5-year plan, the downside risk will be from mis-execution. If management fails to execute as planned, it will impact growth expectations. Also, the economy might not recover in 2024 as I expected, which will impact BURL's growth cadence.

Overall, I am revising my rating from hold to buy. BURL has shown that they can outperform peers - which I believe triggered a strong stock price action - and I expect the business to achieve management's 5-year growth target. That said, I am less positive about how much BURL can expand its EBIT margin, hence, I am expecting EBIT margin to expand by half of what is expected by management. Nonetheless, the stock will still generate attractive returns even with 200bps of margin expansion. The stronger growth profile could also warrant a higher multiple than I modeled, which could enhance the expected returns.

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