Free Cash Flow Valuation 

 McKinsey Free Cash Flow model

Based on the McKinsey Free Cash Flow (FCF) model the stock price of Burlington is overvalued. At the time of calculation (April 10th, 2024) the stock was trading at 195.53. Using the WACC calculated in the previous post, BURL stock's price is 182.02. This post will summarize the methods/assumptions used to arrive at this value. 

Key assumptions/ rates used to estimate the value of Burlington

The rates depicted in figure 2 are the foundation of the Free Cash Flow evaluation for BURL. These rates include the growth rate of revenue, the growth rate of cost of goods sold (COGS), growth rate of selling and administrative expenses (SG&A), the percentage change in the Net Operating Assets (NOA), the percentage growth of depreciation and amortization (Dep.& Amort.), and other operating expenses percentage growth (other Oper. Exp). 

Growth  rates

The growth rate of BURL was calculated based on two assumptions:

1. For the first three years (2024, 2025, 2026) the rate was calculated by taken the average between the FactSet and the Value Line estimates. Figure 3 illustrates this. 

2. For the rest of the year, the calculation was based on a formula that takes into account the final growth rate (2034). The growth rate for 2034 was estimated to be 5% based on where the company is now and believing it will mature by 2034. Additionally, this took into account that for the majority of companies the long-term growth rates are between 1% - 5%.

Cost of goods sold (COGS) rates

The COGS rate was determined by taking the average of FactSet and the Value Line estimates for five FYs (2024, 2025, 2026, 2027, and 2028). Afterwards it remains constant. Figure 5 depicts this. The Value Line COGS rate estimate was computed by taking the forecasted cost of sales and dividing it by the forecasted sales since the report did not provide a COGS growth rate. These estimates were close to the historical COGS growth rates, therefore the estimates from Value Line and FacSet were considered reasonable. 

Selling and administrative expenses (SG&A) rates, depreciation and amortization rates, and other operating expenses 

All these rates were determined based on historical numbers. Selling and Genral Administrative Expenses and Other Operating Expenses were calculated by taking the average of the 2021-2023 FYs expenses. Depreciation and Amortization was calculated by taking the average of the 2022-2023 FYs expenses.

The particular average rate chosen for each was based on the values being in the middle, neither excessively high nor too low which I believe aligns with the growth strategy of BURL. They remain constant for the rest of the years. 

Change in Net Operating Assets rates (Δ NOA)

The change in Net Operating Assets rates were based on calculations involving two models. A vertical analysis for both models was conducted to yield the percentage Δ NOA. The NOA chosen was the average of the 2022-2023 FYs. The lowest NOA investment was chosen to yield a higher cash flow.

For FY 2020 two outliers were taken due to an extreme increase in cash as a result of covid -19. The negative NOA as a percentage of sales that we see in figure 8 means that BURL is investing in operating assets. This is coherent with BURL's strategy of continuous store expansion and driving sales growth.

 Operating income calculations

The operating income must be calculated before the free cash flows can be determined. For the calculation of BURL's operating icome the key rates summarized above were used. The figure below illustrates the calculation. 

Free cash flow and stock price calculations

The figure below depicts the calculation of the free cash flows and the stock price for BURL. The EBIT tax rate used was 26.25% which was the tax rate from the FY 2023. The enterprise value of the firm was determined by taking the net present value (NPV) of all the future cash flows discounted at 9.61%, which is the WACC calculated in the Cost of Capital post. BURL has a high value of debt, which contributes the most towards the low stock price we observe compared with the current stock price of $179 as of April 17,2024. The number of shares was taken from the firm's Value Line report.

Final stock price explanation

Based on assumptions, historical data, and forecasts, BURL's stock is overvalued. The stock price as of April 17th, 2024, is $179. This yields an overvaluation of about $56.1, a downside of -31.3%. Therefore, at this point in time I believe the stock should be sold. 

 BURL has the potential for more growth and is striving towards that goal according to their 10K report. However, over time it will mature as all businesses do and that growth will start to slow down and eventually, the firm will reach a mature growth rate. The time horizon for that growth to happen was estimated to be around 10 years and the reason is because usually after that number of years estimates are not reliable due to many factors. Afer all the future is unpredicable and one can only rely on predictions for so long. 

Link to Excel File