Description

We recommend purchasing shares of BJ’s Wholesale Club (BJ). Put simply, the last 4 years have been about improving the core of the business, and Covid has now launched the company into a new phase of growth yet to be appreciated by investors. BJ is materially undervalued both on an absolute basis and especially when compared to its peers (discount retailers as well as warehouse club Costco).

BJ’s operates 219 membership-based warehouse clubs, concentrated primarily in the northeast United States. Over 6 million members pay $55+ per year to shop in BJ’s stores where they purchase groceries and general merchandise at prices at least 25% cheaper than local supermarkets.

Over the last 5+ years, BJ’s has been a relatively unexciting top-line grower; from fiscal 2016 – 2019, BJ added 1 net new store per year (<1% growth), and comps were 0.3% in total over the 4-year period. However, the bottom line improved dramatically, as EBITDA grew from $406m in Fiscal 2015 to $582m in Fiscal 2019 (EBITDA margins expanded from 3.3% to 4.4%). This led investors to conclude BJ’s had squeezed what it could from the bottom line (under private equity influence), and growth would be limited going forward to whatever topline growth the company could produce, and the historical evidence did not seem to indicate an acceleration was to come. Additionally, net leverage was high coming out of the IPO, and even after material FCF generation net leverage was still 2.9x at the end of 2019.

That said, if one peeked under the hood, there were several positive indicators of future growth. Here is an overlay of comp growth by year alongside membership retention rate:

It’s a bit uneven, but one observes that as the membership renewal rate improved, BJ’s went from slightly negative comps to LSD positive comps.

There are several other reasons as to why comp growth has been low, the primary of which is an aggressive SKU rationalization program BJ’s embarked on, improving its gross margin due to procurement savings with increasing scale but also temporarily reducing comps. For example, BJ decided to go with one branded diaper brand and one private label brand; a member who used to buy Huggies only sees Pampers, and might not buy diapers at BJ’s for a bit – it takes some getting used to before you switch a customer’s brand loyalty; meanwhile BJ’s gets procurement savings from the “winning” brand Pampers by buying much more from one manufacturer.

The advent of the pandemic caused comps to explode in fiscal 2020 – BJ’s has been comping in the 20s through Q3, and will end up growing EBITDA from $582m in 2019 to perhaps $850m in 2020, producing an enormous amount of FCF. Additionally, net new members is up 630k+ on an LTM basis, vs. typically adding 200k-250k members in a year – a future source of comp growth as new members typically spend ~$1k in Year-1 but season over a 2-3 year period to the chain average of ~$2.4k.

The funny thing is, even as BJ stock has moved dramatically this year, the valuation has barely budged.

March 2020:

·         Market Cap: $2.8b

·         EV: $4.5b

·         2020 EBITDA estimate: ~$595m

·         EV / EBITDA: 7.7x

·         Net leverage: 2.9x

November 2020:

·         Market Cap: $6b

·         EV: $7b

·         2020 EBITDA estimate: ~$840m

·         EV / EBITDA: 8.4x

·         Net leverage: 1.2x

Now we know – 2021 is going to be a difficult comp, and EBITDA is likely to decline somewhat. That said, unlike grocers like KR / ACI, BJ’s is about to pivot into a growth story – the combination of many new members + new stores is going to result in material increases in revenues and EBITDA beyond 2021, unlike a traditional mature grocer.

Going forward, BJ’s has announced a plan to build 4 new clubs in Fiscal 2020, 6 new clubs in Fiscal 2021, and 10 new clubs in Fiscal 2022 and beyond, perhaps expanding even faster. So, new-store growth goes from sub 1% to 3% - an additional 2.5 – 3 points of growth long-term.

Additionally, membership retention continues to improve; as BJ adds more members and continues to retain more of its existing members, combined with the new stores’ members maturing into the base, BJ’s expects comps to improve from LSD to MSD. It’s not unreasonable to think BJ should be better at adding and retaining members – Costco retains over 90% of North American members, and has 73k members per club vs. BJ at 28k members per club – there is room for BJ to improve.

The combination of 3% new store growth + MSD comp growth should lead to what we think can be MSD-HSD sales growth beyond fiscal 2021’s Covid comp – this is a material change to the story where BJ was growing like a mature grocer, and it puts BJ’s frankly into the same growth algorithm of its vaunted peer, Costco!

·         Costco grows new stores 2.5% - 3% annually

·         Costco has 91% membership retention in North America

·         Costco comps MSD – HSD on a same-store basis

·         Costco EBITDA margins are 4.6%

·         Costco membership-fee income of $3.5b roughly equal to COST FCF

Compare that to BJ:

·         New store growth will be 2.5% - 3% annually

·         BJ’s membership retention has been mid-80s, improving to 87% in most recent fiscal year

·         This has produced a comp of ~1.5%-2% for the 2 years pre-Covid

·         We would argue Costco’s comp advantage is partially driven by its superior membership retention – where BJ has been closing the gap – you keep more members you drive better same-store comp

·         BJ's EBITDA margins pre-Covid were…4.4%

·         BJ’s membership-fee income in 2021 likely to be ~$360m+, in line with projected FCF

Costco trades 20x forward EBITDA. BJ’s trades less than 10x. Costco gets a premium multiple because of the perception it delivers great value to its loyal customer base, evidenced by its high membership retention rate and superior comps; MFI flowing through to FCF means you get to buy a very valuable and growing annuity. This is basically how BJ will look going forward.

Even when you put aside the relative valuation to COST, BJ's trades at a material discount to the other growing discount-based retailers. It also trades cheaply on an absolute basis – on Fiscal 2022 numbers, sub 8.5x EBITDA and a low-to-mid-teens FCF multiple.

We believe as investors begin to appreciate the growth story at BJ’s beyond the difficult 2021 comp, the stock will re-rate materially.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Accelerating growth in 2022 and beyond will change the perception of BJ being a LSD grower to a MSD-HSD grower; the stock should get rewarded with a higher multiple