Why BJ's Wholesale Club Can Be a Long-term Growth Story

After seeing Costco (COST 1.01%) stock outperform the broad market year after year, investors want to know whether BJ's Wholesale Club (BJ 1.22%) has the makings of another winner thanks to its bulk warehouse retail model.

Below, we consider the strengths of the company, which is already up over 40% since its June initial public offering.

A full transcript follows the video.

This video was recorded on July 24, 2018.

Vincent Shen: We've received a few requests recently to talk about BJ's Wholesale Club. They priced their IPO in late June, last month, at $17 under the ticker BJ. Shares are up about 50% from that level in approximately one month of trading. The chain has actually been around since the 1980s, but BJ's was taken private in 2011 by private equity investors for about $2.8 billion. Those shareholders still own about 70% of the company.

BJ's locations are concentrated on the East Coast. They have 215 stores, 134 gas stations, and about $13 billion of revenue in the trailing 12-month period. That puts its business at about one-tenth the size of industry leader and closest peer, Costco. That matchup was actually the main point of interest from listeners who wanted to know, how do these two companies compare?

Before we get into that, I figure it's helpful to lay some groundwork by hitting the strengths and weaknesses in this retail story. Asit, if you're selling more of the bull thesis for the company, some of the pros, what are the things that jump out to you?

Asit Sharma: Reading through the company's prospectus just before it went public, I was surprised by a number of things. As they'd been private for many years, as you mentioned, BJ's has 3X the number of clubs that Costco does in its core Northeast market. BJ's basically started in the Northeast. That's a lucrative market. The company says that there's disproportionate amount of U.S. GDP concentrated in the Northeast, and that's true to some extent, although we do have some in metropolitan areas. I could make an argument that California also has a great share of U.S. GDP. We'll return to California later in this discussion.

I was impressed that the company has $2 billion worth of annual sales from its two private label brands, Berkley Jensen and Wellsley Farms. BJ's used to have 13 private label brands. It cut these labels down to two and became more efficient with them. It's a well-run business, in the aspect of understanding how this relationship between open goods and private goods functions, and how to maximize that opportunity.

I did want to bring up something for later discussion. The company had about half of its adjusted EBITDA -- earnings before interest, taxes, depreciation and amortization -- from its membership fees. Remember that statistic. When we talk about Costco, we'll return to this.

I like that it has a positioning that's between the warehouse and the grocery store. It has 7,200 stock keeping units, or SKUs, on average. That compares to an industry average of 4,500 SKUs. While you won't see quite the amount of bulk products in a BJ's as you will in a Costco, there are many sections that are more like a traditional grocery store. The company touts that as an advantage. I think it's an advantage, but there's some vulnerability in there as well, because they're straddling two different concepts.

The company also has a warehouse industry-leading average of visits by members. On average, members visit about 22 times a year -- basically twice a month. That's a pretty high frequency for a club membership. More typical is once a month or once every six weeks. There's a distinct advantage there related to its high loyalty. Membership renewal for customers who have been with BJ's for two to three years was around 86% in 2017, and that was an all-time high.

I want to put in one more advantage that the company has, and that is a focus on reasonably well-off households who have an income of $75,000 or above. In a two-earner household, that's not an upper-class income, but it's a very high base level vs. a grocery store's target, which could be $20,000-25,000 below that; or a club target, which would be in the $50,000 range. Dollar stores go below there.

Many nice things popped out from reading this. I think if you're looking at BJ's as a long-term holding, you're interested in the fact that it's situated on the East Coast, it's small in comparison to Costco, it's not straddling the whole United States with a bunch of distribution centers. Small, nimble, with a good handle on running its business.

Shen: I'll add to that. A few things you mentioned, the private label brand is definitely an interesting one, how they've consolidated from that 13 to the two. They've mentioned that those private label brands have doubled their share of merchandise sales in the past five years. So, they've seen a lot of progress there. As we've talked about previously with private labels, they tend to help increase customer loyalty, help with profitability, as well, in terms of the better margins.

Some of the other momentum that I'll close out with for this part of the discussion, in terms of the BJ's Wholesale Club business, is with the comparable sales, they're seeing an uptick there, 2% excluding gasoline sales for the most recently reported quarter. As a result of some initiatives from the CEO, Chris Baldwin, and other members of leadership at the company, they've managed to do things like negotiate $260 million of savings from their suppliers. Profitability for the company has been improving with expanding gross and adjusted EBITDA margins.

Last one for me in terms of a more long-term outlook, I think the concentrated geographical footprint for BJ's Wholesale Clubs on the East Coast leaves it with an opportunity to expand. In the IPO prospectus, the company says that its distribution centers that it currently has can support an additional 100 locations on the East Coast. They plan to open about 15 to 20 new clubs in the next five years. Keep in mind that its 215-club footprint is still quite small compared to both Costco at around 700 and Sam's Club, which is part of Walmart, which is around 600. So, you can see an opportunity both within the East Coast, its area strength, but also moving out broader if it does want to start to expand into other parts of the U.S.