While investors may be intrigued by BJ's Wholesale Club (NYSE:BJ) and its recent initial public offering, choices in the wholesale club industry come down to just two companies: BJ's or its mammoth rival Costco (NASDAQ:COST).
Find out what the Industry Focus team believes makes for a better investment.
A full transcript follows the video.
This video was recorded on July 24, 2018.
Vincent Shen: These next points that I'll make definitely delve more into that direct comparison with Costco that our listeners wanted to see.
Another regular contributor to both Industry Focus and Fool.com, Adam Levine-Weinberg, he wrote a piece soon after the BJ's IPO, laying out his bearish view of the company. He mentioned some pretty sobering points. Something that really jumped out to me, was very eye-opening, he talks about productivity of Costco vs. BJ's locations. Estimates for sales per square foot come in at about $540 for BJ's, but $1,245 for Costco. That helps explain why, even though Costco has about 3.5X the store base of BJ's, it has closer to 10X the revenue. In terms of efficiency and productivity, you can definitely see the difference between these two companies.
Even on a membership basis, Costco locations have about 3X as many members as BJ's clubs, and Costco's customers tend to be even higher income. I think we said that BJ's targets the $75,000 annual income demographic. Costco's customers, closer to $100,000. They tend to spend more.
Even on renewal rates, 86%, pretty strong for BJ's. Renewal rates for Costco are about 4% higher at over 90%. Again, a look into the differences between these two companies, and how Costco, even at its larger scale and size, is able to eke out some stronger points there.
Final thoughts on this comparison. You also have to consider things like the valuation. BJ's shares are trading at about 22X forward earnings. Costco is at a pretty good premium to that at 32X earnings. Something that I look at here, just sales from Costco's Kirkland Signature private label came out to $35 billion in 2017. That's nearly 3X companywide revenue for BJ's.
We mentioned this with Calavo, this is also a space where that scale is really important, when you're working in these razor-thin margins. Having that additional buying power, that negotiating power with suppliers, and having such a strong private label business -- in this case, for Costco -- I definitely think has its advantages.
I'm curious, anything jump out to you for this comparison. Also, what are your thoughts, in terms of somebody who wants to invest in the wholesale club retail niche? Do you have any strong thoughts, in terms of, both companies, one or the other? Where do you stand here, Asit?
Asit Sharma: Let me tackle your first question first, Vince. This idea of square footage productivity is fascinating to me. BJ's is focusing now on an 85,000 square foot concept. For a long time, experts in the industry associated with higher productivity per square foot with smaller stores. Companies like Costco and Whole Foods have turned that notion on its head. Costco's average warehouse size, as investors would know, is about 145,000 square feet.
This is the flip side of the economics that BJ's touts as an advantage -- that it's part grocery store, part wholesale club. If you have an edifice which is almost 150,000 square feet, you have the room to put appliances in, to put garden in, to put a pharmacy in. These are all higher-ticket items and revenue drivers, vs. trying to sell boxes of cereal, not in bulk but as cereal that you'd find in a grocery stores in individual boxes. The disadvantage of having an 85,000 square foot store is, you lose out on those big-ticket items which generate those higher dollars per square foot, and then flow through to the bottom line.
Costco, as I mentioned, has that 2% margin. Those who follow Costco like to look at, what's the revenue for its membership fees? You look at that number, it's almost always very close to what it makes in net profit each year. Everything else is just in and out. That's a formula which Costco has shown they can do at great scale with very large stores.
What I am worried about, too, with BJ's dependence on a quasi-grocery store within its stores is, it's more susceptible than Costco to retail disruption. We're seeing the channels in which people buy their goods change almost overnight in the last ... it's really two years, but it feels like it's overnight, as more commerce shifts to delivery via Instacart, ordering online. I think Costco, with its very strong balance sheet, has more of a means to invest in the technology to compete with e-commerce and the changing ways that consumers purchase.
The last thought, do you buy both of these, do you favor one over the other, I think Costco is still the gold standard as far as warehouse clubs are concerned. BJ's has to show us some operational improvement. We often talk about IPOs, we tell investors on this show, wait a couple of quarters, maybe then take a position, unless it's a really great concept. I would say wait one to two years. I think we need one or two years of data to see how BJ's, under its relatively new leadership, can work this equation of now being a publicly traded company, accessing more expansion in Florida and the Mid-Atlantic, outside of its home base of the Northeast.
I would wait before investing. It's had a good run since its IPO, but it's only been a few weeks. Not a bad business, but not a compelling reason, in these financials, for the narrative, to invest today, from my perspective. What about you, Vince? What are your thoughts?
Shen: I think I'm on the same page. The rule of thumb that we establish with IPOs, in terms of giving them at least a few quarters to value the results as a public company, is really important here. We've seen comparable sales growth at 2% in the latest quarter. How consistent can that be? How well will they be able to keep that up? I'm definitely going to be watching that.
Seeing how well they catch up, in terms of the more efficient operations of their larger competitor, or whether that profitability catches up, the productivity of its stores, once they've established, potentially, this stronger track record of growth, I can definitely see a better story there for an investor. Otherwise, if you're really looking into this space, as you described, Costco is definitely the gold standard. Those are my final thoughts. Anything else from you, Asit?
Sharma: The last thought that I have for both of these companies -- the industry surprised me when I was doing some research for the show. It's still growing, by some sources, at a compounded annual growth rate of 4-6%. I thought, with all the changes coming, especially from the encroachment of companies like Aldi and the German grocer Lidl, the expansion of Wegmans, and the grocery wars that affect that grocery component, that the warehouse segment might have a cloud over it.
Listeners, I found out that it's still a persuasive segment to invest in. At the end of the day, people love to have the membership and the savings that they can rely on through the year. Still not a bad place to invest. If you're curious with everything we see with grocery stores and what's happening to those financials, is that spilling over into this area? Just a little bit, but really not in a significant way.