When I looked at BJ'sWholesale Club (NYSE:BJ) about six months ago, I found the shares to be slightly cheap on a price-to-free cash flow basis. However, they weren't quite cheap enough when compared with BJ's peers Costco (NASDAQ:COST) and Sam's Club, owned by Wal-Mart (NYSE:WMT). Today, I'm still not convinced that the price is right.
Shares are now more than 5% cheaper than they were when I initially wrote about BJ's. The company's performance has been lackluster, but not terrible, and the company did grow. However, I am concerned about the merchandising mix, not to mention some execution errors noted by my colleague Stephen Simpson.
From a sales growth perspective, BJ's is lagging a bit behind Costco and Sam's, which is important considering its smaller size. The company also doesn't turn over its inventory as fast as Costco, and its cash conversion cycle and profit margins consistently lag Costco's as well. Nevertheless, even an inferior company can be a good investment if it is selling at a low enough price. Has BJ's reached that price yet?
A discounted cash flow analysis on BJ's shows that the shares are attractively priced -- if the company has a strong fourth quarter, and if it is able to deliver a free cash flow performance similar to last year's $123 million. However, last year's number fell well outside the company's five-year range of $15 million to $60 million in free cash flow. Over the past 12 months, the company's free cash flow has receded to within its historical range.
Free cash flow is always an important metric when considering a company. Without cash left over at the end of the day, the company has no way to pay dividends, repurchase shares, or fund a new growth opportunity. When comparing BJ's and Costco on a free cash flow basis, it's also important to consider that BJ's leases almost all of its stores, while Costco owns the majority of its stores. As both reach greater maturity, Costco should enjoy a greater relative amount of free cash flow than BJs; Costco's capital expenditures for new stores will decline, but BJ's will still have its lease payments.
Given BJ's unstable free cash flow dynamics, and the relative cheapness of competitors like Wal-Mart, Stock Advisor pick Costco, Target (NYSE:TGT), and Motley Fool Inside Value pick Dollar Tree (NASDAQ:DLTR), I'll pass on BJ's for now. I won't let the company entirely out of my sight, though. Should the shares fall another 15%-20%, BJ's value might become too good to pass up.
For related wholesale Foolishness:
Costco is a Motley Fool Stock Advisor recommendation. Dollar Tree is a Motley Fool Inside Value recommendation.
Nathan Parmelee owns shares in Costco but has no financial stake in any of the companies mentioned. The Motley Fool has an ironclad disclosure policy.
