BJ's: Better Than It Seems

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Executives at BJ's Wholesale Club (NYSE: BJ  ) must be wondering what happened on their second-quarter earnings conference call yesterday. Same store sales were up 15.5%, earnings per share increased 25.5% (excluding one-time items), and the company beat analyst expectations by $0.02 per share. Yet the stock sank more than 7%. Um ... do we have bad breath all of a sudden?

Turns out investors weren't thrilled that, amid so much success, management didn't raise its earnings expectations for the back half of the year. Investors can be a fickle bunch.

By the numbers, I see very few flaws in BJ's Q2 results. Higher gas prices added 8.1% to comp sales; excluding fuel, comps rose a still-healthy 7.4%. That compares favorably to the most recent U.S. quarterly (fuel adjusted) comps of 4.6% from Wal-Mart Stores (NYSE: WMT  ) and 4% from Costco (Nasdaq: COST  ) , and beats the heck out of anything we've seen recently from Target (NYSE: TGT  ) .

Gross margin declined 55 basis points, but operating margin only declined three basis points, thanks to slower-growing operating expenses. The company continues to deliver impressive free cash flow, cranking out $56 million during the 2nd quarter -- much more than its $36 million of net income.

The stock price drop may also have stemmed from a quote from CEO Herb Zarkin, "No rational retailer can accept these kinds of increases and expect to make a profit," which was picked up by some of the wire services. This quote was taken out of context. Mr. Zarkin was predicting that competitors would raise prices, allowing BJ's to do the same. But on a stand-alone basis, the quote sounds like the company sees trouble ahead.

After reviewing the conference call, I think management is taking a conservative line. Gas prices are very volatile. Consumer-products companies like Procter & Gamble (NYSE: PG  ) and Kraft Foods (NYSE: KFT  ) are raising prices, which retailers must decide whether they can pass on to shoppers. And the all-important holiday season still awaits us. I don't blame the company for taking a wait-and-see attitude.

Fellow Fool Rich Smith noted last April a bear case for BJ's from among CAPS' members, but after taking a closer look, he concluded the stock was fairly priced at a P/E of 20. I say "ditto" today at 19 times trailing earnings. Longtime Motley Fool readers will remember that I consider BJ's to be the third-best warehouse club player, after Sam's Club and Costco. But the company has been on a roll for more than a year now, and I see no reason to believe the fun will stop here.

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Kraft Foods is an Income Investor selection. Wal-Mart is an Inside Value pick. Costco is a Stock Advisor recommendation. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Timothy M. Otte surveys the retail scene from Dallas. He welcomes comments on his articles, and owns shares of Wal-Mart, but none of the other companies mentioned in this article. The Fool has a disclosure policy.

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