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Morningstar | Burlington's Profitability Guidance Underwhelms as Year Closes, but Outlook Remains; Shares Rich

After narrow-moat Burlington announced slow sales growth as fiscal 2018 ended and lackluster guidance, we plan a mid-single-digit percentage cut for our $145 per share valuation. As the softness appears attributable to correctable missteps rather than a change in the dynamics underlying our positive view of the off-price channel, our long-term outlook (mid-single-digit top-line growth, 10% adjusted EBIT margin, on average, over the next decade) remains.

In fiscal 2018, Burlington saw $6.6 billion in sales and adjusted diluted EPS of $6.44, versus our $6.7 billion and $6.38 pre-announcement marks. Management expects 9%-10% revenue growth, including 2%-3% comparable store sales expansion and adjusted diluted EPS of $6.93-$7.06, against our 8%, 2.8%, and $7.21 respective targets (our EPS estimate assumes share repurchases; excluding buybacks, our target was $7.08).

Burlington underperformed in ladies apparel and cold weather categories, leading to disappointing 1.3% fourth-quarter comparable store sales growth (trailing our 3% target). While Burlington and Ross reported struggles in the former category, we are encouraged that both firms' challenges were attributable to execution missteps rather than a change in how customers are reacting to the channel (reinforced by TJX's on-track quarter). Burlington struggled in heritage categories and sportswear, with assortment issues we expect to be addressed as it develops vendor relationships in faster-growing ladies categories. The weather misstep partly resulted from insufficient pack and hold inventory entering the season, a forecasting error we see as a byproduct of Burlington's welcome efforts to reduce its dependency on weather-related categories. We expect Burlington's assortment changes and real estate optimization efforts (to continue in fiscal 2019 with 75 gross new stores and 28 remodels) to deliver long-term results, allowing its cost and intangible asset advantages to drive returns growth despite competition.

Our expected valuation cut is more conservative than the shares' 10%-15% swoon after the news was announced. We suspect this is due to our more conservative estimate of the pace of Burlington's optimization efforts. The shares traded north of our valuation before the news; we had stated that sentiment appeared to assume a degree of perfection in execution with which we were uncomfortable. Although the gap between our valuation and current trading prices should narrow after we adjust our forecast, we counsel investors to await a more attractive entry point.