BJ's Wholesale Club



Background
Among the beneficiaries of state-wide lockdowns due to COVID-19 and sudden surge in grocery demand is BJ’s warehouse club who reported a record 27% in merchandise comparable sales for Q1 2020. Since 2018, the company has continuously communicated to investors its strategic plan for long-term growth consisting of, among other things, better in-house assortment of merchandise and stronger focus on acquiring members in its high tier program (BJ’s Reward and co-branded Mastercard). Following strong 1Q 20 earnings, the market has begun pricing in what is shaping out to be a favorable outlook for the company; currently offering a 17% buying opportunity.


Thesis
The company’s fundamentals have been strengthening quarter to quarter with strong tail winds shaping a long-term runway for growth. BJ’s has made incremental progress over the past few years, among which are scaling their digital capabilities (engaging more members in buy-online-pick-up-in-club or BOPIC activities) that tend to skew sales in higher priced merchandise, a focus on enhancing the value proposition for their high tier members (depending less on membership trials), and simplifying merchandise assortments to continuously provide relevant merchandise at attractive prices.

Perhaps more encouraging to the latter progress is Lee Delaney becoming CEO in 4Q 19. Lee had spearheaded the general merchandise (GM) assortment transformation a few years ago, delivering 4% comparable sales in 2019 and 6% 2-year stack during 1Q 20. His leadership in the GM assortment transformation could well be applied to other categories.

BJ’s has lots of room to grow relative to peers and the tailwind of consumer demand for quality merchandise at attractive prices, coupled with a shift in online transactions, are all the factors that can prove to be of benefit to the long-term growth of the business

1. BJ’s has historically averaged north of 25,000 members per club with 87% renewal rate compared to Costco’s 60,000 members per club with 91% renewal rate in the US

2. Their $100million cost saving initiative (Project Momentum) can improve margins

3. Targeted focus on acquiring high tier (BJ’s Perks Rewards and co-branded Mastercard) members shapes a runway for membership fee income (MFI) growth

4. Continuous transformation of assortments throughout clubs’ categories (specifically grocery) can prove to enhance merchandise comparable sales growth as evidenced by performance of general merchandise division following its assortment transformation

5. Increase of value proposition to members via co-branded Mastercard gasoline discounts and other services (optical and cellphones) can be a catalyst to increase in membership

6. Continuous decrease in interest expenses. The company has been actively delivering, strengthening its balance sheet for further growth in their bottom line


Valuation
Projecting a conservative high single digit growth in MFI and net sales (9%) into my 2020E-2021E forecast from the above-mentioned tailwinds, 25 basis points in SG&A margin improvement resulting from continual operational efficiencies of the $100million cost saving initiative (Project Momentum), BJ’s is expected to deliver in the ballpark of $649million in EBITDA 21E. With a current market cap of $5.7billion, BJ’s is currently valued at 13.7x EV/EBITDA 21E.

This is a multiple slightly ahead of the 3Yr EV/EBITDA group average (Discounters/Dollar Stores/Warehouse Clubs) of 11.8x(1), but I argue that for a business that has grown EBITDA for the past three years at a compounded annual growth rate of 8.89% compared to Costco’s 5.08% and earnings at a 3Yr CAGR of 83% compared to Costco’s 15.9%, a 15.2x EV/EBITDA multiple (Costco’s 3Yr average EV/EBITDA multiple) is more reasonable as the company is showing increasing signs of operational efficiency.

As such, BJ’s estimated fair value is $47.93/share, offering a 17% upside from current levels.



Risk

The risk in this analysis is all in the multiple assumption. While I believe there’s a case to be made for the 15.2x multiple given the growth potential and improvements BJ’s has made over the years, it could be the case that:

1. Consumers’ eagerness for value in this recessionary period attracts them more to BJ’s Inner Circle $55/year (compared to Costco’s $60/year) membership program; significantly stalling growth in BJ’s high-tier program (BJ’s Perks Rewards at $110/year)

2. Their grocery division may not experience an increase in performance similar to what they’ve managed to achieve with their general merchandise division

3. The cell phone and optical service may prove to be invaluable in maintaining current and attracting new members; causing further pressure on margins


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