📍 TLDR

• After a 40%-plus rally since November earnings, BURL seems like a slam-dunk short. Shares are trading at over 50x this year’s earnings while the business heads in the wrong direction.

• There may be some logic to the bull case. But with another 11% tacked on already in 2023, the stock has run too far even if the bull case does play out.

• There’s a strong case for either a straight short of BURL and/or a long/short pairs trade with one of its more established peers.

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As we said on our August call, despite [external] headwinds, as an off-price retailer, we should be able to drive stronger performance than this. If you look at the results reported this past week, clearly, we are an outlier within off-price…

Since early September, we have done a lot to sharpen our values, but as I acknowledged back in August, we should have done all of this sooner. In 2022, the consumers' frame of reference for value shifted significantly versus last year. We should have responded more aggressively and more rapidly…

We remain very excited about the ability of off-price to continue to take market share over time. We also remain confident in our ability to improve our execution of the off-price model and thereby, drive higher sales and margins.

Those three quotes (in order) come from the prepared remarks of chief executive officer Michael O’Sullivan on the Burlington Stores BURL 0.00 third quarter conference call. That call took place at the market open on November 22. Price action in BURL since then clearly shows the market believes the CEO:

BURL gained 20.5% on the day of the release, despite what look like awful fundamentals. Same-store sales in the third quarter of FY22 (ending January 2023) were down 17% year-over-year. Full-year adjusted earnings per share is guided to decline by more than half.

Those results, plus an eye-popping valuation of 55x the high end of FY22 EPS guidance, seem to set up a compelling short case.

That’s not the right version of the short case, however. There are reasons why BURL trades at such a high multiple despite such ugly FY22 performance. After this rally, however, those reasons simply aren’t good enough.

Introducing Burlington Stores

Burlington was founded in New Jersey in 1972 as Burlington Coat Factory, the retail outlet of a wholesale suit and coat operation. The company has steadily grown across the country since then, to a current store count just shy of 900. Its assortment has changed dramatically as well, from a core focus on coats to a broader reach that includes apparel, accessories, and footwear. In response, last decade the company rebranded from Burlington Coat Factory to Burlington Stores.

Like better-known peers Ross Stores ROST 0.00 and TJX Companies TJX 0.00, Burlington is an "off-price" retailer. It sources excess, discounted, inventory from dozens of brands (no brand accounts for more than 5% of sales, per the 10-K) and sells at a relatively steep discount to full-price rivals.

Off-price has been a winning model. ROST and TJX without exaggeration have been two of the best stocks in history

Revenue and Profits Plunge

As far as BURL stock goes, it’s important to understand more recent history. And that recent history looks incredibly bearish.

Looking to guidance for FY22, Burlington expects same-store sales to decline 14% to 15%. The company is facing a difficult comparison, admittedly, but the multi-year track record looks incredibly soft: the guided three-year geometric stack

Obviously, the external environment is exceptionally volatile, but as O’Sullivan admitted, peers are performing far better. Q4 guidance from Ross suggests a 4% decline for the full fiscal year (also ending January) against a +13% comparison; TJX expects a 1% to 2% decline vs a 17% year-prior increase.

The concerns for Burlington are even greater below the top line. The company’s full-year adjusted EPS outlook is a range of $3.77 to $4.07, which at the high end is down 52% year-over-year. Here, too, peers are holding up much more strongly, but seemingly the bigger issue for BURL is not relative performance, but the absolute multi-year decline. In fiscal 2019, Burlington generated $7.41 in adjusted EPS, with a modestly higher diluted share count.

Why, Exactly, Is BURL Up 40%-Plus Since Earnings?

In that context, the question is why the market has bid up BURL so aggressively over the eight weeks since the Q3 release. There are two core answers, both of which were referenced by O’Sullivan on the Q3 call.

The first, as highlighted in the quotes at the top of this piece, is that the company simply has so much room for improvement. It’s not as if O’Sullivan is shying away from attributing recent weakness to execution; the CEO followed up his mea culpa by highlighting a series of actions the company had taken to improve its position going forward. It’s expanded the proportion of “recognizable brands”, pulled back on previously planned price increases, and added more reserve onto store floors.

And in the context of the industry and the external environment, it’s not as if a misstep, or even multiple missteps, is unforgivable. Stores were forced to close in 2020 amid the novel coronavirus pandemic, and then in 2021 the entire industry struggled to source product amid supply chain challenges and paused manufacturing. Inflation then skyrocketed in 2022, at the same time many consumers pulled back on product purchases after gorging themselves over the prior ~18 months or so.

So, yes, earnings are plunging this year — but they can snap back in an absolute hurry as execution improves. Indeed, analyst consensus sees FY23 EPS of $6.48 (albeit with a wide range), up 63% year-over-year from the average estimate for FY22.

The second reason for taking the long(er) view is that Burlington, relative to peers, has a greater proportion of lower-income customers

Short-term, then, BURL is benefiting from optimism toward the business — O’Sullivan did cite improved results toward the beginning of fiscal Q4 — and of late likely getting a boost from increased hopes for an economic “soft landing”.

That short-term move aside, the broader story admittedly seems potentially intriguing. Burlington believes it has continued room for store count expansion, with a maintained goal of 2,000 stores, more than double the current footprint. As noted, share price performance since the second IPO has been sterling. And there are still improvements to be made beyond simply fixing 2022 errors. It’s not just O’Sullivan talking up better execution on conference call; Burlington’s own presentation from November emphatically makes a similar point:

source: Burlington Stores investor presentation, November 2022

The rally since mid-November isn’t a silly ‘meme’ rally or the sign of a market gone mad. We can see why investors bought BURL during that run. That doesn’t, however, mean they were right to do so — or that the bull case here isn’t missing some pretty significant issues.

Valuation Matters

Perhaps the most notable problem at this point is that the valuation incorporates that bull case — and then some.

It’s fair, certainly, to argue that the mid-50s P/E multiple (based on FY22 results) is somewhat misleading here. Whatever the precise cause, this clearly is a trough year.

But Friday’s close of $225 is pricing in the company’s peak earnings. Shares trade at 27x fiscal 2021 adjusted EPS, a record year for Burlington and a year in which net/net the external environment at worst looks neutral. Sourcing was a challenge, and flush consumers may have been more willing to pay full-price, but demand across retail clearly was at a multi-year high. Burlington’s EBITDA margins were about in line with pre-pandemic levels, and the two-year comp stack was ~7% annualized. FY21 unequivocally was not a trough year.

Based on consensus, BURL is also trading at 27x FY24 EPS, for which consensus is pretty much equal to the FY21 result. Even that consensus estimate looks potentially aggressive. It requires 60%-plus growth in FY23 and another 40% the following year, even though O’Sullivan said after Q3 that [emphasis mine] “we are optimistic about some recovery in sales and margin next year.”

The company’s five-year plan, which is cited in the November presentation and appears to have been released last year, suggests FY26 EPS of about $17. That figure seems incredibly optimistic, and our working assumption would be that it's no longer valid

BURL simply has a massive valuation problem even if the qualitative bull case is correct. Indeed, even with a pair of “top idea” upgrades from the Street over the past six weeks, the stock still trades 4% above the average analyst price target.

The Problems With The Bull Case

Meanwhile, there are reasons to believe the qualitative bull case is not correct. Inflation is moderating, but still running higher than most would like. The idea that Burlington’s core customer is going to snap back in 2023 seems misguided.

That same sense holds for the industry as a whole, and the idea that the lower demand seen amid a 2022 pivot to spending on entertainment and activities mean 2023 is going to be “normal”. ~20% of Burlington revenue comes from the ‘home’ category, a category that might still have some lingering demand issues.

Longer-term, the room for footprint expansion is intriguing. But the argument from Burlington that smaller stores will improve unit economics and overall margins is somewhat refuted by the fact that margins haven’t increased even with the strategy in place for a few years now.

And, of course, at the end of the day investors are still relying on improved execution from a company that by its own admission completely misread its market over the past few quarters. Burlington has made broader claims about expanding its buying team and the like, but (as is so often the case) the retailer’s argument is basically “we’ll execute better by executing better.”

The problem with that argument is that it isn’t how retail works — particularly in a competitive space with two long-established rivals performing well. Retailers don’t always get room for a hiccup.

To be fair, Burlington is large enough that institutional investors buying here likely have some directional sense of holiday performance, in particular. That aside, Burlington’s pre-pandemic performance no doubt provides some confidence in its post-pandemic future. But there’s even a concern there. Burlington’s business did impress for a few years — but during and coming out of the financial crisis, the business lagged. Comps were negative in FY08 and FY09 while Ross was positive, which is a piece of evidence against the argument that consumers will trade down to Burlington in an inflationary environment. From FY11 through FY13, same-store sales growth averaged about 1%.

Upside/Downside

The bullish narrative here is that a hugely attractive business briefly lost its way amid a difficult environment, and will shortly get back on its growth path. That’s not guaranteed to be the case. And even if it is, it’s difficult to see how that narrative is not already priced in.

That in turn seems to set up a reasonably attractive risk/reward from the short side. There clearly is a ton of pressure on FY23 guidance, due with the fiscal Q4 release in early March. Nothing short of a massive beat against consensus (which, again, projects an increase in adjusted EPS of more than sixty percent) seems likely to move the stock higher.

Any kind of disappointment, meanwhile, undercuts the currently dominant narrative. Burlington’s return to peak earnings gets pushed out a year (or more), the belief that execution problems will be easily fixed fades, and BURL gets repriced based on FY23 EPS guidance, not a hoped-for two-year return to the FY21 level. There’s a relatively reasonable scenario here in which the stock drops 40%: a low-20s multiple to low-$6 guidance gets the stock to the $135 range.

In a still-volatile external environment, and after a difficult FY22, missing consensus would not be a stunning surprise. That’s particularly true when a ‘miss’ here is defined as EPS growth in the range of 50%. That fact alone shows just how high expectations for Burlington are — and just how disappointed the market can get.

As of this writing, Vince Martin has no positions in any securities mentioned. He may initiate a short position in BURL this week.

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