Burlington Stock: Best Pick In Off-Price Retail (NYSE:BURL)

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burlington (NYSE:BURL) shares have been hit hard thus far in 2022, with the stock off 52% year-to-date. Shares have significantly underperformed off-price retail peers Ross Stores (ROST) and TJX Companies (TJX) which have seen share price declines of 18 and 7%, respectively. While Burlington’s operational results have been far worse than TJX and Ross, I believe that results will normalize as inflationary pressure recedes (eventually). Looking out to 2025, I see more than 70% upside in the stock.

Burlington Overview

Burlington is the third largest off-price retailer in the US, with annual sales of about $9 billion. Sales have more than doubled since 2013 as same store sales have increased, while the store count has grown to just under 900 locations today.

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Overview (Burlington Investor Presentation)

While Burlington has an impressive track record of growth, with just 900 stores, it has a much smaller footprint than TJX and Ross which have 2,500 (TJ Maxx & Marshall’s) and 1700 stores, respectively. In addition, as shown below, Burlington has an opportunity to increase store-level productivity as sale/store and operating margins meaningfully lag peers

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Key metrics for Off-Price retailers (Burlington Investor Presentation)

Off-Price Retail Is A Long-term Winner

Traditional apparel retail is a very difficult business. Department stores like Macy’s (M) and Kohl’s (KSS) have seen a decades-long decline in market share, profitability and stock prices. Mall-based retailers like Gap (GPS), Abercrombie (ANF), and American Eagle (AEO) have suffered a similar fate. However, traditional retail’s losses have been off-price retail’s gain. Over the past decade the big 3 off-price retailers (TJX, Ross, Burlington) have seen their collective sales more than double from $30 billion to over $60 billion. Why has off-price retail succeeded where others have struggled?

1. Lower pricing – off-price retail sells products 20-60% below department store prices. As I discuss below, off-price retailers have a competitive advantage in their cost structure, which allows them to pass savings on to customers.

2. Treasure hunt mentality keeps increases customer visit frequency – off-price retailers have a constantly changing assortment of products (stores receive deliveries of new products 1-2x per week) which keeps customers coming back regularly and reduces the need for expensive advertising and aggressive discount.

3. Significant buying power ($55 bn in annual merchandise purchases)/ buying overstocked/out-of-season items allows off-price retailers to procure products at a lower cost than traditional retailers.

4. Most off-price retailers are located in shopping centers (as opposed to malls). On average, off price retailers spend 4-5% of revenue on rental expense versus mall-based retailers which spend 11-12%.

5. Limited service model reduces in-store labor costs – off-price retail is a self-serve model – there aren’t many sales associates and checkout lines are longer (customers make the trade-off of longer lines/less service for lower price).

Current conditions

Burlington’s massive underperformance versus peers in 2022 is largely attributable to its lower income customer base. While this was a tailwind in 2021 as stimulus checks flooded this economy and customers spent aggressively, the absence of stimulus in 2022 has led to a reversal of this impact.

Further, while most TJX stores are located in areas with annual household income above $75,000, Burlington stores target less affluent households ($55,000 and below). Lower-income households are more impacted by inflationary pressures as customers re-allocated spending from discretionary items like apparel to necessities (the cost of rent, gas, and food have all increased significantly in 2022).

As a result of these factors, Burlington has seen significant same-store sales declines as lower income consumers are being more heavily impacted by inflationary pressure. In 2Q22, Ross (customer household income somewhere in between TJX and Burlington) saw a comparable sales decline of 7% year-over-year, while Burlington experienced a whopping 17% decline. By contrast, TJX saw its comparable sales slip just 2% in its Marmaxx (TJ Maxx & Marshall’s) division.

Valuation & Conclusion

I believe that over time, economic conditions and spending behavior of lower-income houses will normalize. I assume Burlington will continue to execute on its playbook of increasing its store count while gradually improving its operational metrics (sale per store/sq ft and operating margins).

Assuming Burlington is able to achieve a 10% operating margin on a revenue base just north of $12 billion in 2025, I get to $14 per share in EPS. My revenue estimate assumes a 3% annual increase in same store sales and that Burlington continues to grow its store count by 90 stores per year.

While my 10% operating margin assumption seems like a big improvement from the sub-5% Burlington will likely do in 2022, it is only a modest improvement from 2021’s 8.6% which suffered from stratospheric freight costs (these are now coming down -discussed in my recent SA piece on TJX) as well as pandemic related costs (such as additional cleaning costs). For reference, Burlington achieved a 9.2% operating margin in 2019 (the last truly ‘normal’ year) while Ross has historically earned 13-14% operating margins and TJX has historically earned 13% margins in its MarMaxx (TJ Maxx/Marshall’s) segment .

Applying a 17x P/E multiple (historically off-price retailers have traded between 16-20x earnings), this gets me to a value of $238 per share which is 72% above the current share price, which I see as an attractive entry point for a long term winner.

risk

Should inflation remain high, this will likely pressure low-income household spending and continue to depress Burlington’s results.

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