Burlington Stores, Inc. (NYSE:BURL) Q3 2023 Earnings Call Transcript

Burlington Stores, Inc. (NYSE:BURL) Q3 2023 Earnings Call Transcript November 21, 2023

Burlington Stores, Inc. misses on earnings expectations. Reported EPS is $0.98 EPS, expectations were $0.99.

Operator: Hello, and thank you for standing by. My name is Krista, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Burlington Stores, Inc. Fiscal 2023 Third Quarter Earnings Conference Call [Operator Instructions] I would now like to turn the conference over to David Glick, Group Senior Vice President, Investor Relations and Treasurer. David, you may begin your conference.

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 third 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 express permission. A replay of the call will be available until November 28, 2023. We take no responsibility for inaccuracies that may appear in transcripts of this call by third parties. Our remarks and the Q&A that follows are copyrighted today by Burlington Stores.

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 through 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. This morning, we will share a few comments on our third quarter results and our forecast for the rest of the year. But then we are going to devote most of our remarks talking about our longer-range financial expectations. We will also provide some early thinking on the outlook for 2024. Okay. Let’s start with our Q3 results. Comp store sales for the third quarter increased 6%. This was the midpoint of our guidance range of 5% and to 7%. During the quarter, we were very pleased with our back-to-school trends. Our quarter-to-date comp growth through September were slightly ahead of our guidance range, but then unseasonably warm weather in October slowed this trend.

Of course, we have a very strong heritage in outerwear. So warmer temperatures in October tend to have a more negative impact on us compared to other retailers. Overall, given this unfavorability in weather as well as the general softness across discretionary retail, we were pleased with our third quarter performance. For the fourth quarter, we are maintaining our previously issued comp store and adjusted EPS guidance. We are up against our toughest multiyear compares and the external economic environment is uncertain. Our guidance is for comp growth in the range of negative 2% to flat. We are pleased that November is off to a solid start, but the highest volume weeks are still ahead of us. I’m going to move on now and talk about our longer-range financial model.

Some time ago, we had said that we would update our longer-range model this year. I am going to share the main headlines from this model, and then I will discuss the key assumptions behind these headlines. While any long-range model is, of course, subject to various uncertainties we think it is important and helpful for investors as well as vendors, landlords and other constituents to understand where we are headed. Okay, the main headlines. Over the next 5 years, we expect to grow our total sales to approximately $16 billion. This represents about 60% of aggregate growth versus 2023. We project that our average growth rate each year for total sales will be in the low double digits. We expect our operating income over this period to grow to approximately $1.6 billion.

In dollar terms, this is almost 3x our forecasted 2023 operating income. As a percentage of sales, we expect our operating margin to be approximately 10% by 2028. The assumptions that underpin this financial model can be grouped into 3 main buckets: new store sales, comp store sales and operating margin. Starting with new store sales. Over the next 5 years, we now expect to open approximately 500 net new stores on our current pace of over 1,000. These will be comprised mostly by our 25,000 square foot prototype located in busy script malls. We feel very good about the economics of these stores. We also plan to relocate or downsize a substantial number of our older, less productive and oversized locations. We anticipate 2 to 3 dozen of these store relocations and downsizes each year.

We have a high degree of confidence in our ability to execute these new store openings and relocations. As you would expect, our plans for 2024 are well advanced. And our new store pipeline beyond 2024 looks healthy. There may be some lumpiness year-to-year, but still, we expect to achieve the aggregate number of net new openings that I have just outlined. We anticipate that this new store opening program will be the most significant driver of our annual double-digit total sales growth. I’m going to move on to comp sales growth. Looking at the next 5 years as a whole, we expect that our average annual comp sales growth will be in the mid-single digits. The starting point for this average annual mid-single-digit comp assumption is that prior to 2020, our average comp growth was in the range of 3% to 4%.

This comp trend was interrupted by the pandemic. And over the last 3 years, it has been positive 15% followed by minus 13%. And now for fiscal 2023, we are forecasting positive 3%. We anticipate some continued variability year-to-year. In some years, our comp growth may be below mid-single digits and in some years, it may be above. That said, we believe that the extreme pandemic era volatility is now behind us. In fact, this is evident in our 2023 year-to-date comp trend. As we look at the outlook for off-price and for our core customer over the next 5 years, we think that this 3% to 4% baseline is a good starting point for our model. But there are strong reasons why we believe we can outperform this baseline over the 5-year period. Firstly, since 2019, we have taken numerous steps to make our business more off-price these steps have included strengthening our merchandising capabilities and making our operational processes more flexible.

These are not unproven strategies. They have driven the success of our off-price peers over many years. We recognize that over the last few years, we have introduced a lot of change all at once. And this has impacted our ability to achieve the level of execution that we would have liked. Also, we have been rolling out these changes — at the same time, as the external environment has been difficult. Since early 2022, our core customer has been under significant economic pressure. But let me get back to my main point. It is important to understand that leaving aside for short-term challenges, the strategies we have been pursuing to become more off-price are not unproven strategies. Over the next few years, we expect these strategies and our improved execution of these strategies have a growing and positive impact on our results.

In addition, our new store and relocation programs have the potential provide a helpful comp tailwind over time. This will not happen right away. In fact, as we ramp up our new store openings, in 2024, there will be some slight cannibalization of comp stores by the newer stores. But then as the new stores join the comp base, they typically out-comp the chain for several years. As more and more new stores join our comp base, we believe this tailwind to comp growth could increase. One other point to note is that when we relocate older stores, we typically see a nice sales lift. This makes sense. We are moving to a better, more up-to-date store in a busier location. We expect that this could be an additional comp tailwind in in the next few years as we increase relocations.

Okay. I am going to move on now and talk about our operating margin. Based on our latest 2023 forecast, we have lost about 300 basis points of operating margin since 2019. This has been driven by higher supply chain costs, mostly labor rates and higher freight costs. In the next 5 years, we expect to offset all of this, 300 basis points and more, taking operating margins to approximately 10% in 2028. Let me describe the key components of this expansion. Firstly, there are a number of savings opportunities that are unrelated to sales growth. We estimate that these are worth about 200 basis points. And we expect to capture the majority of these savings over the next few years, starting with about 50 basis points in 2024. There are 3 main sources of these savings.

Higher merchant margin, mostly lower markdowns, lower freight expenses, partially from lower freight rates, but also driven by specific transportation initiatives and lower supply chain expenses again, driven by specific efficiency and labor productivity initiatives. There may be additional upside in supply chain expenses through investments in distribution center automation. But our expectation is that these benefits may take longer than 3 years and we have, therefore, not included them in these savings estimates. The second major source of margin expansion is sales leverage. There are 2 forms of this total sales leverage and comp sales leverage. By growing total sales at double-digit rates, we expect to capture leverage on G&A costs, including buying and planning expenses and costs related to corporate functions.

In addition, if we grow comp sales at mid-single-digit rates, and we should be able to leverage store-related fixed costs such as occupancy — over the next 5 years, we expect to capture about 200 basis points of margin from these sources of sales leverage. Let me segue now to our initial thinking on 2024. Although we believe that over the next 5 years, we can achieve average annual comp sales growth in the mid-single-digit range, we are planning 2024 more cautiously than this. There is a lot of economic, political and geopolitical uncertainties. It is difficult to predict what this uncertainty might mean for our business. In addition, over the past couple of years, we have implemented a lot of changes in our business, and we think that it makes sense to be cautious about how quickly these changes may have an impact.

So for 2024, our initial forecast is for 2% comp growth. With this 2% comp growth, we expect to capture about 50 basis points of operating margin expansion next year. At this point, I would like to hand the call off to Kristin to discuss more financial details on Q3, our long-range model and 2024.

Kristin Wolfe : Thank you, Michael, and good morning, everyone. I will start with some additional details on the third quarter. Total sales growth in the quarter was 12%. This was slightly lower than we had expected, driven by later opening dates for new stores during the quarter as well as a shift in a handful of new store openings into the fourth quarter. In Q3, we opened 38 net new stores, bringing our store count at the end of the quarter to 977 stores. For the full year, we now expect to open approximately 80 net new stores. Our comp sales growth in Q3 was 6%, which was the midpoint of our range of 5% to 7%. As Michael described, we were very pleased with our comps trend through September had then softened due to unseasonably warm temperatures in October.

As a point of reference, at this time of year, cold weather merchandise categories, such as outerwear, represent about 25% of our business. Many shoppers still think of us as Burlington Coat Factory. So as you would expect, our comp trends strengthened when the weather finally turned cooler at the start of November. Our adjusted EPS in Q3 was $1.10, which was near the high end of our range of $0.97 to $1.12. This result and the guidance range excludes approximately $10 million of expenses associated with the Bed Bath & Beyond stores that we acquired earlier this year. As a reminder, these expenses are mostly dark rent for the period between the acquisition of the leases and this time that the stores will open. The gross margin rate for Q3 was 43.2%, an increase of 200 basis points versus last year.

This was driven by a 150 basis point increase in merchandise margin, mostly driven by lower markdowns and a 50 basis point decrease in freight expense. Product sourcing costs were 10 basis points higher than last year, driven by higher supply chain costs. These costs have been a headwind all year. But as we have discussed, we have identified and developed a number of specific initiatives to drive efficiency savings and labor productivity improvements in our distribution centers over the next few years. Adjusted SG&A costs in Q3 were about 50 basis points higher than last year, which included 40 basis points of deleverage attributable to expenses related to the recently acquired Bed Bath & Beyond leases. Excluding those expenses, the slight SG&A deleverage was driven by a deliberate decision to increase staffing levels in our stores.

We were not happy with the service levels in our stores last year and the increase in store payroll is intended to address this. Our Q4 guidance and our initial plans for 2024 include this additional store payroll. Q3 adjusted EBIT margin was 4.8%. 210 basis points higher than last year compared with guidance of 170 basis points to 220 basis points. Again, this excludes Bed Bath and Beyond costs worth 40 basis points. Turning to Q4. As Michael mentioned, we are maintaining our guidance for the fourth quarter. This guidance is based on comp sales of negative 2% to flat versus last year. We expect that this current range should lead to a Q4 adjusted EPS of $3.10 to $3.25. Including the 53rd week, which has adjusted EPS of approximately $0.05 Q4 adjusted EPS is expected to be in the range of $3.15 to $3.30.

Now I would like to share some additional details on our long-range financial model. These additional details may be useful to understand our underlying assumptions in developing this model. Starting with new stores. We expect to average about 100 net new store openings a year over the next 5 years. As we have described previously, we expect new stores to open at about 70% of our average store volume. New stores joined the comp base about 15 months after opening. And then they typically out comp the chain for several years. As a reminder, our underwriting hurdles for new stores require that they be EBIT accretive in their first full year with the relevant performance title being based on our 2019 EBIT margin. Over the next 5 years, we also expect to relocate a substantial number of our older less productive oversized stores.

When we relocate a store, we typically see a comp sales lift for that store and improved profitability. The comp lift averages about 10%. The new store is usually close to the old location within a 0.5 mile, but it’s typically in a better and busier sensor. Our goal when we relocate a store is to retain the existing customer and also importantly, to pick up new customers’ traffic. As Michael described, we expect that our new store openings, together with mid-single-digit comp sales growth should drive low double-digit total sales growth over the next 5 years. Now let me review our long-range assumptions for operating margin. We have identified savings opportunities unrelated to sales leverage, that are worth about 200 basis points. We believe that we can capture most of these savings in the next few years.

In addition, over the next 5 years, we expect about 200 basis points of expansion, driven by the leverage on total sales and on comp sales growth. This means that if sales perform in line with our projections, then we anticipate that our operating margin over the next 5 years should increase to approximately 10%. The pace at which this happens will depend on year-to-year sales growth. One other point to call out is that in order to support new store growth and the expansion of distribution center capacity, we are planning to increase our CapEx spending. We expect CapEx to run at about 7% of sales for the next few years before dropping back to around 5% of sales. We expect to generate a lot of cash in the next 5 years sufficient to fund the growth needs of the business while still returning excess cash to shareholders.

Let me wrap up with some additional details on how we are thinking about 2024. We are in the midst of our 2024 budgeting process. But right now, our working assumption is for top line growth of about 11%. This is driven by 2% comp store sales growth plus 100 net new store openings. We also expect about 30 store relocations in 2024. As described earlier, in 2024, with 2% comp sales growth, we expect to capture about 50 basis points of margin expansion. We have more work to do, but we feel good about our detailed plans for going after these savings. As a reminder, we typically generate 10 to 15 basis points of operating margin leverage for each point of comp ahead of the sales plan. Of course, the comments that we have made today regarding our 2024 plans are preliminary and subject to change based on the developments over the next few months.

We will provide final guidance in more detail during our Q4 call in early March. I will now turn the call back to Michael

Michael O’Sullivan: Thank you, Kristin. Let me summarize the key points that we have discussed this morning. First of all, briefly on Q3, given the softness across retail and the unfavorable weather in October, we are pleased with our Q3 comp and earnings performance. Meanwhile, November is off to a solid start, and this gives us confidence in our previously discussed Q4 guidance. Secondly and more importantly, we have spent most of these remarks talking about the longer-term outlook. The last few years have been extraordinarily volatile and unpredictable. But that volatility has started to wane. We are very bullish about the prospects for our business. We expect to grow our top line sales by about 60% in the next 5 years driven by our new store opening program and comp store sales growth.

We also see significant opportunity to recover and drive our operating margin. Compared to 2023, we expect our operating margin in dollar terms to almost triple in the next 5 years. Lastly, for 2024, we are developing our initial plans based on 2% comp store sales growth and 50 basis points of operating margin expansion. If the underlying sales trend turns out to be stronger, then we will be ready to chase. And if we achieved sales above plan, then we would expect additional operating margin expansion. With that, I would now like to turn the call over for your questions.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Matthew Boss from JPMorgan.

Matthew Boss: Great. And really appreciate all the additional color. So Michael, on your initial comp sales assumption for 2024, which calls for 2% growth, is that comp assumption being driven by specific concerns about the outlook next year? Or should we think of it just being driven by your standard off-price playbook of planning comp sales conservatively and being ready to chase?

Michael O’Sullivan: Matt, thank you for the question. The direct one is that it’s a bit of both. There are valid reasons to be cautious and it makes sense to manage our business this way. Clearly, there’s a lot of concern and anxiety among analysts and investors about the external environment, the economy, retail sales and especially about the low-income consumer. And to that, there’s obviously a lot of uncertainty about the political and geopolitical environment. We’re not economic experts. So it’s difficult for us to assess all those risks and to calibrate the potential impact on our business. We also know that many of the improvements that we’ve made over the past few years, especially the new tools and processes that we’ve rolled out in merchandising will take time to gain momentum.

They are going to have a significant impact, but that impact is likely to build over time. The last thing I’ll say is that when we came into 2023, we had bigger expectations for the strength of our sales trend this year. Our business has gotten stronger this year. Our comp is running at positive 5% year-to-date. But we’d actually hoped for a little bit more. I think that those higher expectations hurt us in some parts of our business, we may have over planned sales. And then when the trend turned out to be a little weaker, it made it harder for us to pull back. In retrospect, it might have turned out better for us if we plan our business a bit more cautiously this year. So putting all those things together, given all the uncertainty, given the changes we’ve made in our business, given some of the lessons from this year, we think a 2% comp growth assumption is an appropriate one at this point for our budget for 2024.

We hope the trend is stronger. We’re very confident that if it is, we’ll be able to chase it.

Matthew Boss : Great. And then to follow up, Kristin, could you share any more details of the 200 basis points of margin opportunity that you cited as unrelated to sales? And maybe just more specifically, any additional color that you can provide on the 50 basis points that you think you can capture in 2024 would be great.

Kristin Wolfe : Yes. Good morning, Matt. Thanks for the question. As you said, and we said in the prepared remarks, we do expect to capture about 200 basis points of margin expansion in the next few years, unrelated to sales leverage. There are really 3 main sources of these savings. First is higher merchandise margin. This is mostly driven by lower markdowns and while we have made meaningful progress increasing merch margins, but we continue to believe we have opportunity to turn faster and reduce markdowns further. The second area is in lower freight expenses these savings in freight are driven by lower freight rates as well as specific transportation initiatives that we have to optimize outbound and inbound processes and drive efficiencies throughout our transportation.

We’ve made good progress on freight. By the end of this year, freight will be less than 100 basis points higher than 2019 levels, and we believe that we can recover more of this in the next few years. The third area is the third area of opportunity is from lower supply chain expenses, really driven by productivity and efficiency initiatives in our DCs. As you know, and as we’ve talked about, we’ve significantly increased the level of closeout or true off-price buys. These all require more time to process in distribution centers. We’ve also substantially increased our use of reserve inventory. So we’ve had a significant number of learnings, and we’re focused on numerous efficiency initiatives to: one, reduce labor hours and processing these buys two: more efficiently manage the flow of goods in and out of reserves.

And lastly, to minimize the number of touches in our distribution center and finally, as it relates to the last part of your question as it relates to 2024, we expect 50 basis points of EBIT expansion on a 2 comp. And as we said in the prepared remarks, we’re still in the midst of the budgeting process. We have more work to do. But at this point, we have good line of sight and fairly detailed plans for going after this 50 basis points of margin expansion and it includes a combination of leverage from these 3 items we talked about, merch margin, freight expenses and supply chain.

Operator: Your next question comes from the line of Ike Boruchow from Wells Fargo.

Ike Boruchow : A couple of questions. First, thank you, everyone, for the information and the long-range financial model, very helpful. I guess if I just take a step back, be interested if there’s any commentary on where you think the biggest risks are in the model when you look at? And I guess maybe specifically, are there any major risks that could undermine the financial projections that you guys have, whether it’s revenue or margin or just anything there would be helpful?

Michael O’Sullivan: Okay. Yes, it’s a good question. It’s something I’ve thought a lot about. Let me — I’m going to describe and editorialize three sets of risks in the model. I’ll start with long term or structural risks. This is my third decade in off-price retail. And as long as I’ve been in the industry, there have always been some commentators who are worried that off-price is going to run out of market share or run out of supply or that it will be eclipsed by some new innovative business model or perhaps some new technology. Now of course, it’s important that we always be alert to those kinds of structural risks but I have to say that I’m extremely skeptical. I see nothing out there that seriously threatens the long-term growth of off-price.