Burlington Stores, Inc. (NYSE:BURL) Q2 2023 Earnings Call Transcript

Burlington Stores, Inc. (NYSE:BURL) Q2 2023 Earnings Call Transcript August 24, 2023

Burlington Stores, Inc. beats earnings expectations. Reported EPS is $0.6, expectations were $0.43.

Operator: Thank you for holding. And welcome everyone to the Burlington Stores Fiscal 2023 Second Quarter Operating Results Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session [Operator Instructions]. I will now turn the call over to David Glick, Group Senior Vice President, Investor Relations and Treasurer. Mr. Glick, please go ahead.

David Glick: Thank you, operator, and good morning, everyone. We appreciate everyone’s participation in today’s conference call to discuss Burlington’s fiscal 2023 second quarter operating results. Our presenters today are Michael O’Sullivan, our Chief Executive Officer; and Kristin Wolfe, our EVP and Chief Financial Officer. Before I turn the call over to Michael, I would like to inform listeners that this call may not be transcribed, recorded or broadcast without our expressed permission. A replay of the call will be available until August 31, 2023. We take no responsibility for inaccuracies that may appear in transcripts of this call by third parties. Our remarks on the Q&A that follows are copyrighted today by Burlington Stores.

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Remarks made on this call concerning future expectations, events, strategies, objectives, trends or projected financial results are subject to certain risks and uncertainties. Actual results may differ materially from those that are projected in such forward-looking statements. Such risks and uncertainties include those that are described in the company’s 10-K for fiscal 2022 and in other filings with the SEC. All of which are expressly incorporated herein by reference. Please note that the financial results and expectations we discuss today are on a continuing operations basis. Reconciliations of the non-GAAP measures we discuss today to GAAP measures are included in today’s press release. Now here’s Michael.

Michael O’Sullivan: Thank you, David. Good morning, everyone, and thank you for joining us. I would like to cover three topics this morning. Firstly, I will discuss our second quarter results. Secondly, I will share our outlook for the rest of the year. And thirdly, I will talk about our new store opening program. Then I will hand the call over to Kristin to walk through the financial details. Okay, let’s talk about our Q2 results. Comp store sales for the second quarter increased 4% versus our guidance of 2% to 4%. This represents a 3% comp store sales growth versus 2019 on a geometric GAAP basis. This was very similar to our trend in Q1 and it means that for the spring season as a whole, our comp store sales growth was 4% on a one year and 3% on a four year geometric stat basis.

We are a little disappointed with these numbers. As we came into 2023, we guided to 3% to 5% comp growth. Year-to-date, on a four year basis, we are at the low end of this range. We had hoped to do better. As discussed previously, we believe the key external factor negatively influencing our underlying sales trend is the health of the low income shopper, our core customer. This demographic continues to be under significant economic pressure, Increases in the cost of living, which had a huge impact on this customer’s discretionary spending last year have moderated but not but of course, these costs are still going up. Add to that, these lower income shoppers have been impacted by lower benefits and lower tax refunds in the first half of 2023.

So overall, while there has been some moderation in the headwinds facing this customer, their discretionary spending is still significantly constrained. Our strategy with this customer has been to focus on great value, especially at opening price points. We are pleased with our execution of this strategy, we are driving strong turns and margins at these price points. But this is an area where we can and must continue to improve. As any off price merchant will tell you, showing value at opening price points is one of the most difficult things to do. It’s not just about price it’s about offering fashion, quality and even a great brand at these low opening prices. I feel much better about our values at opening price points now than I did last year but these values are really critical to our core customer, so we need to get even better and sharper in all aspects of opening price point value.

As we have said before, this economic cycle has been unusual in that while low income shoppers, our core customers, have been impacted by inflation, other demographic groups, higher income groups have been relatively [unscathed]. Coming into 2023, we thought it was possible that if the overall economy slowed down then we might see more trade down traffic in our stores and this could potentially offset some of the weakness among our lower income customers. Our strategy for going after these trade down shoppers has been to increase the mix of recognizable brands and to offer great value across good, better, best price points within the assortment. Our merchants have done a nice job executing this strategy. The mix of recognizable brands is much higher now than last year and our values are significantly stronger.

Again, this is a strategy that we need to continue to push and improve. Our good, better, best value strategy has been helped by the fact that there is a very strong availability of off price branded merchandise. This strong supply environment means that not only have we been able to increase our mix of recognizable brands at great value, but as Kristin will describe later in the call, we have also been able to drive up our merchant margins. Although we feel good about our execution of this strategy, we have not seen as much trade down activity in our stores as we would have liked. The fact is that the overall economy has not slowed down significantly, unemployment levels remain low. We have seen some trade down traffic, but so far, the impact of this on our trend has been lower than in previous cycles.

Let me move on now and talk about our outlook for the rest of the year. It is important to start by putting our year-to-date comp trend into context with our expectations coming into the year. Our comp guidance for the full year was 3% to 5% on a one year and similarly, 3% to 5% on a four year geometric stat basis. This guidance was predicated on three things. Number one, improved execution, which we feel like we’ve achieved. Number two, some moderation in the impact of inflation on lower income households. As described a moment ago this has happened but it has been partially offset by lower benefits payments and tax refunds. The lower income shopper is still struggling. And number three, an increase in trade down traffic in our stores driven by a slowdown in the economy.

Again, as described earlier, the overall economy has not really slowed down. Our actual year-to-date comp growth of 3% on a four year basis is at the lower end of our full year comp guidance range. We are disappointed with this year-to-date trend but given the commentary that I have just provided this trend makes sense. We are now planning the full season based on 2% to 4% geometric comp stack. The midpoint of this range is what we have achieved year-to-date. This means that we are narrowing our full year guidance versus 2022 from a range of 3% to 5% to a range of 3% to 4%. In a moment, Kristin will break out the guidance for Q3 and Q4 and she will explain that we are applying the same logic, the same 2% to 4% geometric tax for both quarters.

Again, our year-to-date comp trend is the midpoint of this range. Kristin will also discuss the earnings implications of this comp guidance. But before we go there, I would like to provide a brief update on our new store opening program. We are, by far, the smallest of the major off price retailers. And as discussed previously, we believe that we have a significant opportunity to increase our store count. Also, as discussed previously, we are very excited about our smaller store prototype. For a number of historical reasons, our stores have always been much larger than our peers and they have tended to be in less well traffic, less visible and less desirable locations. As a result, our sales productivity per square foot and our individual store economics are inferior to our off price peers.

In addition to adding new stores, we have an opportunity to relocate and downsize many of our older and less productive locations. Our stated goal has been to open in excess of 100 net new stores a year. But given the lack of real estate availability over the last few years, we have struggled to hit this number. As we announced in March this year, we expect to open between 70 and 80 net new stores. I’m glad to say that the supply of great real estate locations has opened up significantly over the last several months, driven especially by the winding down of Bed Bath & Beyond. There are two main implications of this that I would like to discuss. Firstly, we have acquired 62 store leases directly from Bed Bath & Beyond. It is unusual for us to acquire leases from another retailer even in the bankruptcy.

We would typically wait until the store locations revert back to the landlord. The benefit of acquiring leases directly is that we get to cherry pick the locations that we’re most interested in. The downside is that as soon as we acquire the lease, we start paying rent even though it may take six to nine months to prepare the location and open the store. In a moment, Kristin will provide details on these expenses. Given the timing, we do not expect these stores to have a material impact on our net new store count or on our total sales this year. These stores will largely benefit us in 2024. Secondly, in addition to these 62 stores, there are many other former Bed Bath & Beyond locations that may be of interest to us once they are returned to their landlord in the bankruptcy process.

So as we look at our pipeline of store locations, we are now much more confident in our ability to open the number of new stores that we would like in 2024. At this point, it is too early to provide specifics on our 2024 new store opening program, but we will do that at a later time. Now I would like to turn the call over to Kristin.

Kristin Wolfe: Thank you, Michael, and good morning, everyone. I will start with some additional financial details on Q2, then I will move on to our outlook for the rest of the year. Total sales in the quarter were up 9%, while comparable store sales were up 4%. This means that for the spring season as a whole, our comparable store sales have grown 4% on a one year basis and 3% on a four year geometric stack basis. The gross margin rate in Q2 was 41.7%, an increase of 280 basis points versus 2022’s second quarter gross margin rate of 38.9%. This was driven by a merchandise margin improvement of 150 basis points and a 130 basis point decrease in freight expense. The higher merchandise margin was driven by higher markup, lower markdowns and by lower shortage expense versus Q2 of last year.

The higher markup reflects the very strong off price buying environment that Michael described earlier. Product sourcing costs were $183 million versus $157 million in the second quarter of 2022, increasing 50 basis points as a percentage of sales. Buying expense and supply chain costs, both contributed to this deleverage. Adjusted SG&A was $587 million versus $518 million in 2022, increasing 90 basis points as a percentage of sales, largely in line with our expectations, driven primarily by the timing of marketing spend, higher store related costs and higher corporate expense. The Bed Bath & Beyond leases had a 10 basis point negative impact on adjusted SG&A in the second quarter. Adjusted EBIT margin was 3.1%, 100 basis points higher than the second quarter of 2022.

Excluding the impact of the recently acquired Bed Bath & Beyond leases, adjusted EBIT margin would have been 110 basis points higher than the second quarter of 2022. All of this resulted in diluted earnings per share of $0.47 versus $0.18 in the second quarter of 2022. Adjusted diluted earnings per share were $0.60 versus $0.35 in the second quarter of 2022. The Bed Bath & Beyond related expenses had a $0.03 negative impact on the adjusted earnings per share in the quarter. At the end of the quarter, our in-store inventories increased by approximately 1% on a comparable store basis. At the end of Q2, reserve inventory represented 45% of our inventory versus 52% last year. In 2022, we had built up our short stay reserve inventory due to the lingering supply chain delays, which are not impacting us this year.

Therefore, we are able to carry a lower level of reserve inventory while still taking advantage of a very strong buying environment. As a point of comparison, our reserve inventory is still significantly ahead of prepandemic levels, up nearly 90% since 2019. This reflects the fact that compared with our history, we are making much greater use of reserve to chase off price buying opportunities and hold for later release. During the quarter, we opened six net new stores, bringing our store count at the end of the second quarter to 939 stores. This included nine new store openings and three relocations or closures. Now I will turn to our updated outlook for fiscal 2023. Please note that the following guidance excludes costs associated with the leases on 62 stores recently acquired from Bed Bath & Beyond.

These expenses, primarily dark rent, will negatively impact the third and fourth quarters of fiscal 2023 by $0.11 and $0.09 per share respectively. Together with the $0.03 impact incurred in the second quarter, this translates to an expected full year negative impact from Bed Bath & Beyond lease acquisitions of $0.23 per share. As Michael described, based on how these store leases were acquired, we immediately incur expenses for these stores while we are remodeling and converting. Revenues and profit from these stores will largely benefit us in fiscal 2024. Of course, this timing was factored into our detailed financial assessment of these lease acquisitions. These store locations had strong pro forma economics and are in locations or strip malls where we would otherwise have a difficult time finding a suitable new store opportunity.

So we are very excited to be adding these store locations to our network. We are updating our full year sales and earnings guidance as follows: we now expect full year fiscal 2023 sales to increase 11% to 12%, which includes a comp sales outlook of up 3% to up 4%. Based on this comp sales outlook, we expect our adjusted EBIT margin to increase by 80 to 100 basis points and our adjusted earnings per share to be in the range of $5.60 to $5.90, which compares to our previous guidance of $5.50 to $6 issued back in March. As a reminder, this guidance excludes the impact of the $21 million of expenses relating to our acquisition of Bed Bath & Beyond leases and includes $0.05 of earnings per share from the 53rd week. As Michael mentioned, we are planning a 2% to 4% increase for the fall season on a four year geometric stack basis.

The midpoint of this range is what we’ve achieved year-to-date. So for the third quarter, we are guiding to a one year comp sales increase of plus 5% to plus 7% which on a four year geometric stack basis translates to a 2% to 4% increase. Based on this comp sales outlook, we expect operating margin expansion of 170 basis points to 220 basis points versus Q3 of 2022 and adjusted earnings per share guidance to be in the range of $0.97 to $1.12. For the fourth quarter, our updated full year outlook implies comp store sales of negative 2% to flat, which, again, is based on a plus 2% to plus 4%, four year geometric comp stack. Based on that outlook, on a 13 week basis, we expect Q4 adjusted EBIT margin to be flat to up 40 basis points and adjusted earnings per share guidance to be in the range of $3.10 to $3.25.

When including the $0.05 benefit from the 53rd week, we expect adjusted earnings per share for the fourth quarter to be in the range of $3.15 to $3.30. I will now turn the call back to Michael.

Michael O’Sullivan: Thank you, Kristin. Before we open up the call to questions, I would like to summarize some key points from today’s call. Firstly, for the spring season as a whole, we achieved 4% comp growth on a one year basis. This represents a 3% geometric comp stack. We are a little disappointed with these results. We are happy with our major strategies, but coming into the year, we had hoped that external factors would be more favorable. In particular, it is clear that the low income shopper, our core customer is still struggling. Secondly, looking forward to the second half of the year, we are adjusting our guidance to line up with our year-to-date trend. The midpoint of our guidance range for Q3 and Q4 is a 3% geometric debt comp, the same as our year-to-date trend.

If the underlying trend is stronger then we are ready to chase it. Thirdly, we are very excited about the opportunities that have opened up to expand our new store and our store relocation programs. We are, by far, the smallest of the major off price retailers and historically, our stores have been physically larger than our peers and have had core economics. The increased supply of attractive real estate locations gives us more confidence in our ability to achieve our new store opening targets over the next few years. At this point, I would like to turn the call over to the operator for your questions.

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Q&A Session

Operator: [Operator Instructions] Matthew Boss with JPMorgan, your line is open.

Matthew Boss: Congrats on a nice quarter. So Michael, larger picture, maybe compared to broader retail, the big three off price retailers reported healthy same-store sales year-to-date. I guess what’s your assessment of how off price is performing relative to other retail channels, and any commentary on the relative performance among the major off price retailers?

Michael O’Sullivan: I think the first thing I would say is I agree with you. Off price, off price looks like maybe it’s starting to pull away from traditional retail. On a one year basis, year-to-date comp performance for the major off price retailers has been in the mid to high single digit range, positive mid to high single digit range whereas for department and specialty stores, it looks like it’s mostly been negative. I don’t think that that’s too surprising. It feels like perhaps we’re starting to revert to the longer term structural trends that prevailed before the pandemic, where off price over many years gained share at the expense of other bricks and mortar retail. I think maybe that’s what we’re going back to. The second point I would make though is that within off price, there continues to be a very significant divergence in relative comp performance between the off price chains, especially when you compare us all on a multiyear basis.

When you look at the numbers, we at Burlington, we’re at the lower end of that performance range. I think that the factor that perhaps best explains that relative performance is the difference in core customer profiles between the different retailers. Those differences didn’t really matter historically. But in the last 18 months, lower income shoppers have been differentially impacted by the higher cost of living and by the scaling down of pandemic era benefits. Our strength — at Burlington our strength is with shoppers who are younger lower income and more ethnically diverse and in the longer term, this is a really great core customer. But since early 2022, these shoppers have really been struggling. When you look at other discretionary retailers that serve lower income customers, I think you see the same pattern.

We all performed differentially well in 2021 and then we’ve outperformed differentially poorly since early 2022, and I think that correlates with the spending power of lower income shoppers. But let me wrap up my answer by making one final point. I like that our off price peers are doing well, it gives me encouragement. And Burlington 2.0 is all about becoming more off price. But the strong performance of our peers demonstrates, if you like, the art of the possible in off price. We know that right now, we’re facing strong customer headwinds and we have been since early 2022, but those headwinds are not going to last. And the strong performance of our peers gives me confidence in off price, but it also suggests that we have a big opportunity once the discretionary spending of our core customer begins to recover from this inflationary cycle.

Matthew Boss: Maybe, Michael, just a follow-up on your back half guidance. So the logic of basing the forecast on the year-to-date multiyear comp trend it makes sense and seems as if you’ve derisked the guide. But relative to some other retailers that actually raised the back half and 4Q assumptions, are there any specific concerns that are causing you to be more cautious?

Michael O’Sullivan: There were really [two] factors that drove our thinking on the updated guidance. Number one, our year-to-date comp trend on a four year bank basis is 3%. It was 3% in Q1 and it was 3% in Q2. So it feels reasonable to reset our guidance for Q3 and Q4 based on this year-to-date four year stack trend. Q3 of last year was our weakest quarter. So that logic means that mathematically, our Q3 one year comp guidance is 5% to 7%, again, consistent with the multiyear trend we’ve seen year-to-date. I should also add that we’re very happy with our sales trend August month-to-date and that trend gives us further confidence in the guide. That said, of course, we’re only three weeks into the quarter. The second factor that drove our thinking on our back half guidance is that we know that if the trend turns out to be stronger then we can chase it.

In fact, my assessment is that we always perform better when we plan cautiously and then chase that puts us in a stronger position to respond to what the customer is telling us. And in this environment where availability is exceptionally strong, we know we can find great merchandise to support a stronger trend. Now in your question you asked whether there’s anything specific, any specific concerns we have that are making us cautious. And the direct answer is no. Of course, there are risks, the impact of student loan repayments or unpredictable weather in October, but we don’t have any special insight or intelligence into those. Our continual guidance was much more straightforward, it’s based on year-to-date trend and confidence that we can chase the trend if it turns out to be stronger.

Operator: Irwin Boruchow with Wells Fargo, you line is open.

Irwin Boruchow: I actually have two questions for Kristin, both on the new stores. I guess, firstly, can you provide any detail on your expectations in terms of new store economics and I guess, in particular, as you’re opening more stores over the next few years? How should we be modeling things like new store volumes, four wall margins, margin impact to the stores, just things like that would be helpful?

Kristin Wolfe: I’ll first speak to new store sales volumes and then speak to the margin impact from new stores. On sales, for modeling purposes, you should assume that on average, new stores will have sales volumes of about 70% of an average store in their first full year. This equates to about $7 million in sales and then these new stores will then slightly outperform the chain in terms of comp growth for the first few years. On the margin side, while there may be a handful of exceptions but we typically only approve a new store location if we believe it will be accretive to our overall operating margin in year two, and the hurdle we use here is based on our 2019 operating margin. And of course, it’s not just about operating margin we also apply an IRR hurdle.

On average, new stores have a very attractive IRR. As we’ve shifted our new store openings towards a greater mix of the smaller prototype locations, we’ve seen an increase in both sales productivity as measured by sales per square foot but also operating margin per store. The smaller prototype locations, they have superior economics to our older oversized stores. So with that said, though, it’s important to point out that when you segment our overall store base, it’s still the case that approximately 80% of our stores are larger than 30,000 square feet and about half of our stores are larger than 45,000 square feet. So we still have a lot of oversized and less productive stores in our chain. That’s one of the reasons why we’re very excited about the expansion of our new store opening program.

Irwin Boruchow: And then I guess staying on the topic of new stores, Kristin. Curious have you done any analysis on the degree to which the new stores kind of cannibalize your existing stores? I guess specifically is the number of store openings increase, will that create a headwind to comp growth? How do you think about cannibalization?

Kristin Wolfe: Actually, it’s a good question. It’s something we’ve looked at. Of course, as you indicated, we know that as we open new stores, we cannibalize older existing stores to some degree. The cannibalization effect is relatively modest, though, when you compare with the incremental sales volume that a new store generates. I can share some additional data here. Over the last four years, we’ve opened about 250 net new stores. These stores represent about 30% of our 2023 year-to-date sales. And we estimate that this group of stores has cannibalized sales in our existing stores by about 3 to 4 percentage points since 2019. In other words, new stores have represented a headwind of about 1 point of comp each year since 2019.