Burlington Stores: Not Yet Investable (NYSE:BURL)

Background

Burlington Stores, Inc. (NYSE:BURL) is an American off-price department store retail chain. The company’s business model is based on offering a wide range of merchandise at discounted prices, typically 20-60% off regular retail prices. They sell clothing, footwear, home goods, and accessories for the entire family. They are able to offer these discounted prices by purchasing merchandise from manufacturers and other retailers at a discount, and then passing the savings on to their customers.

BURL (formerly known as Burlington Coat Factory) was founded in 1972 by Monroe Milstein. The company started as a single store in Burlington, New Jersey, selling coats and other outerwear.

During the 1980s and 1990s, the company expanded rapidly, opening new stores and acquiring other retail chains. In 2013, the company went public and changed its name to Burlington Stores, Inc. to reflect the broader range of merchandise that it now offered.

In recent years, the company has continued to expand its store base, both through new store openings and acquisitions. As of 2022, the company operates more than 900 stores across the United States and Puerto Rico and has a strong reputation as an off-price retail chain.

Track Record

When I invest in a business, I consider five things: how much the company is growing, how profitable the business is, how much debt the business has, the intangibles, which include management and industry, and the valuation. My investment strategy is based on finding companies on the right side of the average in these five categories. I plan to find 7-10 businesses that fit this description and hold them for the long term (multiple years). By constructing a portfolio of above-average companies at favorable prices, above-average results can be achieved, perhaps not immediately but eventually.

In this section I will look at the company’s management’s track record for growth, profitability, and debt management. BURL is led by CEO Michael O’Sullivan. He has been the CEO of the company since September 2019 and has extensive experience in the retail industry.

Before joining Burlington Stores, O’Sullivan served as President and COO at Ross Stores, Inc. (ROST) for 16 years, a retail company that operates more than 1400 stores across the United States. Prior to joining ROST, Michael worked at Bain & Company as a partner for nearly 12 years. While at Bain & Company O’Sullivan focused on its business strategy and performance.

O’Sullivan is credited with leading the company’s expansion and implementing effective cost-saving measures that have helped the company maintain its profitability. Under his leadership, the company has also focused on expanding its product offerings and strengthening its relationships with vendors and suppliers.

Since joining BURL, O’Sullivan has led the company to record high revenue in 2021, before dipping slighting over the past 12 months. Even before O’Sullivan joined BURL, the company had established an impressive track record for growing sales which grew 93% over the previous decade.

However, the impressive track record for revenue growth has yet to translate to free cash flow. Free cash flow growth is essential because free cash flow is the actual cash that runs through the business and can be used to pay back debt, invest in growth opportunities, or returned to shareholders.

The company’s debt has ballooned in recent years. This may be a turn-off to many investors, as BURL’s debt-to-equity ratio is currently a sky-high 7.35. The company’s current ratio could be a lot higher, too, at 1.12. As a conservative investor, I shirk at companies with this much debt. I’ve always liked this Warren Buffett quote about debt.

I do not like debt and do not like to invest in companies that have too much debt, particularly long-term debt. With long-term debt, increases in interest rates can drastically affect company profits and make future cash flows less predictable. – Warren Buffett

In addition, BURL doesn’t yet have a steady track record of profitability. Over the past decade, the company’s return on equity has been all over the board and has recorded several years of negative ROE’s. The company has been more profitable since O’Sullivan took over, reporting ROEs of 60.7% in 2021 and 24.20% in 2022, but this is hardly long enough to be considered a sufficient track record of profitability.

Future Growth

BURL has committed to focusing on three main initiatives to increase the business’s profitability. These initiatives include driving comparable store sales growth, expanding and enhancing its retail store base, and improving operating margins.

The company plans to drive comparable store sales growth by more effectively chasing the sales trend by closely analyzing current sales trends so they can capitalize on opportunistic inventory buys. It also intends to operate with leaner inventories in hopes of faster inventory turns, lower markdowns, and improved customer shopping experience. Finally, the business seeks to enhance existing categories and introduce new categories to expand the depth and breadth of its product offerings.

BURL’s efforts to expand and enhance its retail store base include continuing its organic growth strategy. Since its founding in 1972, 99% of its stores have been developed organically. Recently, BURL has been opening smaller store formats. These smaller stores have allowed the company to identify numerous market opportunities to open additional stores and achieve its long-term target of operating 2000 stores. During BURL’s 3Q22 earnings call, the company had plans to open 39 new stores during the fourth quarter, bringing the company’s total store count to 927 stores, with 87 new stores opened in 2022.

The final part of BURL’s strategy is enhancing its operating margins. The company will improve operational flexibility to stay ahead of current consumer trends to achieve this goal. BURL will also seek to optimize markdowns to maximize sales and gross margins. Part of this strategy is the plan to carry less inventory in its stores. Less inventory equals faster turnover, therefore, fewer markdowns. Also, BURL will enhance its purchasing power which it hopes to achieve by leveraging new economies of scale driven by its increased store count.

Valuation

To estimate BURL’s intrinsic value, we will run comparative and discounted cash flow (“DCF”) analyses. To begin, we’ll start with the comparative analysis and look at the highest, lowest, and median price-to-earnings ratios the market has paid for BURL over the past five years. We’ll also look at the sector median P/E, which is 14.44. Finally, we’ll multiply these ratios by BURL’s next year’s consensus EPS estimate of $6.44 per share.

Scenario	P/E	Jan 2024 EPS estimate	Intrinsic Value Estimate	% Change from Current price
Bear Case	17.38 – March 18, 2020	$6.44	$111.92	-50.31%
Base Case	33.04 – 5 -year Median	$6.44	$212.77	-5.54%
Bull Case	314.48 – Jun 3, 2020	$6.44	$2025.25	799.11%
Sector Median Valuation	14.44	$6.44	$92.99	-58.71%

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On a comparative analysis, BURL has a wide range of scenarios that can play out. Investors could realize an excellent 799.11% return if the market were bullish and applied the 314.48 multiple, seen in 2020, to next year’s average analyst earnings estimate, should those estimates materialize. However, I am skeptical that this scenario will play out. The 314.48 P/E ratio didn’t occur because investors were bullish on the stock. Instead, this sky-high ratio came to be because BURL’s earnings had dropped significantly more than its price. Therefore, the bullish scenario in this exercise is unrealistic.

On the downside, the rest of the scenarios can be found. Investors could experience particularly bad results if the bear case plays out and even worse results if the market were to value BURL at the sector median valuation. With an unreliable bull case scenario, and the other three scenarios resulting in negative returns for investors, this comparative analysis indicates that BURL is overpriced.

Turning to the discounted cash flow (“DCF”) analysis, we will begin by taking the average of the last five years of free cash flows, which is $231 million. Please note that there have been two years of negative free cash flows in the last five.

Then we will apply a 6% growth rate for the next ten years based on rule 72, which states a 6% growth rate will double the original value in 12 years. We will follow rule 72 for this DCF because it’s challenging to accurately forecast free cash flow growth rates multiple years into the future. Still, I am confident that BURL will be able to come close to doubling its free cash flow over the next ten years.

Following the 10th year, we will use a 2.5% growth rate into perpetuity to determine the terminal value. We will then use a discount rate of 10%. I use this discount rate because it’s my personal required rate of return. With these inputs, the DCF analysis gives us an intrinsic value of $57.44, representing a downside of -74.88% from BURL’s current share price.

If you believe a 6% growth rate over the next 10 years is too conservative, consider that BURL would need to grow its free cash flow 24% per year over the next decade for its current share price to match the estimated intrinsic value from this DCF, which is highly unlikely. As it stands now, BURL is overpriced.

Take Away

When I look to invest in a business, I consider five things; how fast the company is growing, how profitable the business is, how much debt the business has, the intangibles, which include management and industry, and the valuation. Unfortunately, BURL does not fit my investment criteria.

For me to consider Burlington Stores, Inc. investable, the company and its current management need to establish a long-term track record for persistent growth and superior profitability compared to its industry and broader market. I understand the industry and business model well enough, but the Burlington Stores, Inc. business needs to pay down its debt, and the valuation needs to come down dramatically. For now, I’ll rate Burlington Stores, Inc. as a sell, but if you disagree, please let me know in the comments section.

Thank you for reading!