Should Investors Bet on the New Burlington Stores?

Should Investors Bet on the New Burlington Stores?

Burlington Stores, Inc. has returned to the public markets with a bang, currently sitting more than 70% above the $17 initial public offering price from early October. After undergoing a Bain Capital-led leveraged buyout (LBO) in 2006, the owner of Burlington Coat Factory retail stores spent the past few years revamping its off-price operating strategy in a bid to better compete with the segment leaders, The TJX Companies and Ross Stores Inc. .

As a private company, it was able to focus on improving the customer experience and efficiency of its stores, including remodels of more than two-thirds of its overall store base. So, should investors buy in now?

What's the value?
Burlington Stores is the No. 3 player in the off-price retail segment with roughly 500 stores, trailing far behind industry leaders TJX and Ross Stores with approximately 3,200 and 1,200 stores, respectively.

While the company pursues the same brand-conscious, middle-class demographic as its competitors, it has historically utilized a much larger store format, averaging 80,000 square feet, which has limited its locations to higher- populated areas that could support its stores.

However, with consumers increasingly gravitating to the off-price retail sector, Burlington Stores is seeing more opportunities in smaller markets and hopes to eventually build a store network encompassing 1,000 domestic locations.

In FY 2013, Burlington Stores has generated accelerating revenue growth, with a 9.8% top-line gain that benefited from both higher comparable-store sales and selective additions to its store base. Its adjusted operating profitability posted an even better result, up 36.5%, due to store improvement initiatives that led to a pickup in per-store productivity.

More importantly, the increase in profitability has allowed Burlington Stores to accelerate its inventory purchases in support of its growth ambitions, inline with management's plan to add 25 stores to its network in the next year.

Capital is king
On the downside, Bain and its partners took a pound of flesh prior to the public offering, paying themselves a $336 million dividend that pushed the company's debt to roughly $1.7 billion. Unfortunately, the off-price retail segment requires a strong balance sheet to allow for opportunistic buys of so-called "packaway" inventory that is held for disparate periods of up to one year.

Both TJX and Ross Stores have net cash positions on their balance sheets, which afford them flexibility in their operations and have enabled them to grow throughout business cycles.

Industry leader TJX is having a solid year in FY 2013, with revenue up 8%, aided by higher comparable-store sales and an expansion of its global network of stores, mostly in its T.J. Maxx and HomeGoods units.

More notably, it generated double-digit growth in operating income by providing the right product mix at the right prices, a task that is aided by an efficient purchasing organization of 900 employees that span 10 countries. The better-than-expected growth this year led TJX to recently up its long-term goal for total stores to 5,150, nearly 60% higher than the current level.

Meanwhile, Ross Stores has also been performing solidly in FY 2013, with almost identical top-line and same-store sales growth rates as its larger competitor. Its operating profitability has likewise been trending higher, approaching the mid-teens range as it builds greater critical mass in existing markets.

The higher profits are providing the cash flow necessary to build out a national operating footprint, while giving Ross Stores the ability to return capital to shareholders through share repurchases.

The bottom line
Burlington Stores came public at an opportune time, given rising customer traffic and sales for the off-price segment of the retail industry. According to data provider NPD Group, the segment grew at a compound annual growth rate of 5% for the three years ended December 2012, one of the better performances in the retail trade.

Burlington Stores has also made its primarily self-service, warehouse-like stores more navigation friendly and turned over much of its store management personnel in a bid to create greater efficiency and productivity at the local store level.

However, Burlington Stores has an uphill battle against its two primary competitors, TJX and Ross Stores, both of which generate double-digit operating margins and have much better financial profiles. As such, investors may want to let this newly public retailer try to deliver on its growth and margin-improvement plans prior to taking a position.

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