3/1/2010
By Brian Sozzi, Research Analyst

More Articles by Brian Sozzi

Where have All the Retail Sales Gone?

Are there Any Reasons to Sniff Around in Unloved Retail Stocks?

Discounts are the Theme for August Same-Store Sales

BJ's Wholesale Club Inc. (BJ) announces its 4Q09 earnings results on March 3.  In spite of an acceleration in comps as 4Q09 trekked along, it's probable that the overall report from BJ's will be on the lackluster side.  Items supporting our view include:

1. Weak holiday sales in discretionary merchandise departments, such as jewelry and softlines, as consumers opened up to making purchases at department stores and even Costco Wholesale Club (COST), where the selection tends to be more compelling.
2. The increase in comps reflects increased sales of gasoline, a low margin proposition for BJ's that may exacerbate margin softness in other categories.
3. Though inventory per club was down slightly entering 4Q09, storm activity on the East Coast (we estimate 72.0% of the store base was exposed to storms) likely caused an increase in the markdown rate for holiday merchandise.
4. Continued spending on "IT Roadmap" initiative, which according to recent filings may not conclude until 2012/2013.

Shares of BJ's are valued at the lowest PE multiple based on projected 2010 and 2011 earnings within our discount retail sector coverage.  We believe this valuation is justified as a result of BJ's highly concentrated East Coast store base (lack of diversification increases risk of business), less buying leverage over supplier base relative to competitors, small private level business (11.0% of sales), and no definitive sign that current investment spending will yield a pickup in EPS growth.  For instance, BJ's has averaged a reinvestment rate of 13.89% the last four quarters, but ROC has only been slightly higher than 12.0%. 

We believe BJ's is in a catch 22 of sorts; opening a new club could cost $20.0-$27.0 million and given soft consumer spending may extend the payback period for the investment.  The company's operations are so centralized on the East Coast that to expand in the West, for arguments sake, BJ's would have to invest in distribution in addition to a new store. Finally, building a new technology platform to squeeze increased growth from exiting assets is negatively impacting near-term growth, though we acknowledge this investment may be the lesser of the evils we just outlined.

End result: avoid the stock

Brian Sozzi
Wall Street Strategies