2023-12-11 03:27:19 ET
Summary
- BJ's Wholesale Club trades at a discount compared to Costco, attracting investors seeking a bargain.
- While BJ's and Costco have similarities in their business models, they are far from being comparable.
- Costco maintains a higher expansion pace, with steady margins and efficiency, and best-in-class brand image for value proposition.
- BJ's struggles with fluctuating margins, underperformance in terms of growth and comparable sales, and constantly loses market share to Costco.
BJ's Wholesale Club ( BJ ) trades at a discount compared to retail giants like Costco ( COST ). Operating with a similar business model, investors who are deterred by Costco's relatively higher P/E, seek what on paper seems like a bargain. Some market participants even claim that BJ's is the next Costco, based solely on the merits of its currently significantly smaller size.
Following another quarter of underperformance, it's time to demonstrate why BJ's is not the next Costco, and why investors who go for the simple P/E comparison route here end up disappointed time and time again.
The Wholesale Club Business Model
Of course, there are plenty of similarities between Costco and BJ's, just like there are plenty of similarities between Apple ( AAPL ) and HP Inc. ( HPQ ), or Visa ( V ) and PayPal ( PYPL ). The problem is that operating in the same sector, having a similar business model, or even selling substitutive products, doesn't mean these are identical companies.
So yes, both Costco and BJ's are in essence wholesale clubs. Such members-only clubs sell goods in bulk and provide ancillary services like gas and optics, typically for a significant discount compared to "regular" retailers.
They are able to do so as they rely on a stable stream of high-margin membership fees, which increase loyalty and reduce shrinkage. Additionally, they can exploit their buying power to buy the goods from suppliers at an attractive price, and as bulk sellers, the maintenance and logistics of their stores are cheaper.
Counterintuitively, wholesale club shoppers are higher-income consumers , although they are consumers who are willing to pay for the best-value deal. The explanation for this paradox is that lower-income consumers have less room for non-essential expenses such as a membership fee which needs to be paid in advance. Furthermore, the membership and discounts become more and more valuable the more the member shops, which demonstrates both the attractive customer loyalty it creates, but also the problem for a lower-income consumer to justify such expense.
To conclude this point, we can say that Costco and BJ's operate under a similar business model. But as we'll see, that's pretty much the only similarity between them. Let's switch gears to the very important difference.
Margins
To understand the importance of steady margins in this business we need to go back to what we discussed about the business model. In essence, the majority of the value proposition wholesale clubs and Costco specifically provide is low prices, with the rest coming from rewards and convenient return policies.
As we can see, Costco's gross merchandise margin is steady as a rock, whereas BJ's margins fluctuate. On paper, someone might say that BJ's margins are better, making it superior, but in this case, the opposite is true.
Costco is able to maintain such a steady margin because whenever it gets a better price from suppliers, it passes the entirety of it to customers, with a goal of maintaining a gross merchandise margin of 11%. This enables two important things - one, Costco is reliably considered the cheapest option, and two, suppliers are more willing to drop prices because they know it'll produce more volume, rather than go to Costco's bottom line.
And here's another clear advantage. Despite Costco's significantly lower gross merchandise margin, and even though BJ's membership revenues as a percentage of total sales are higher than Costco's, the gap between their operating margin is very small. Obviously, this can be attributed to Costco's unparalleled efficiency, which is best-in-class across every line of the company's business.
To conclude this margin point, we can safely say that BJ's is very far from replicating Costco's efficiency, its operations are quite different, and it doesn't have the same brand image of being the cheapest option, which affects its relationship with customers and suppliers.
Market Share
From time to time, you hear people refer to a company as "the next XYZ". We had that with Shopify ( SHOP ) and Amazon ( AMZN ), we have that with Celsius Holdings ( CELH ), and Monster Beverage ( MNST ), and we see that with BJ's and Costco. While some comparisons are more valid than others, the basis of this argument should begin with the smaller company taking market share from the bigger company.
As we can see, the bigger company is actually taking share from the smaller one, consistently for the past few years. Aside from 2020, Costco outgrew BJ's every year, on a growth percentage basis (and obviously absolute dollar basis).
Costco is not only taking share from BJ's on the total sales front, but it is also taking share on the membership revenue front, demonstrating it remains the top choice for customers.
So I think we can fairly establish BJ's Wholesale is not going to be the next Costco. At best, it's growing on par with Costco, but with lower operational stability.
Footprint & Comparable Sales
This is where the difference really jumps out of the screen. Today, Costco operates 871 warehouses, whereas BJ's has 239 clubs. Such a gap in numbers could suggest that Costco is a significantly more mature company, but surprisingly, Costco is only one year older than BJ's, founded in 1983. Furthermore, Costco spans operations worldwide, and all across the U.S., whereas BJ's clubs are mostly situated on the East Coast.
Just to get a grasp on the difference between Costco's expansion pace relative to BJ's, since 2007, there were only three years in which BJ's outgrew Costco on a relative basis (percentage growth), and none where it outgrew Costco on an absolute basis.
Now the significantly lower growth would have been easier to digest if BJ's demonstrated an ability to grow same-store sales on par with Costco, and that is far from being the case. As we can see above, BJ's constantly trails Costco by a significant margin, with an outlier of the Covid year.
Valuations & Growth Prospects
Fundamentally, BJ's is simply not Costco, and in my opinion, I see no scenario where it becomes remotely close. But that's not such a terrible conclusion, considering Costco is one of the best businesses in the world.
So the question is what does draw investors to BJ's, given the undeniable gap in quality? And the answer, I think as often is the case when it comes to inferior businesses, is the P/E ratio.
So here it is, there's a whopping gap between the companies' valuations. A gap has always been there, and there's no reason to believe will narrow, as the fundamental differences between the companies are only widening.
Looking at the companies' respective growth prospects, Costco still has a more ambitious expansion plan, as well as e-commerce initiatives like Costco Next. BJ's on the other hand is still working on achieving more efficient and stable operations, while working around the slowdown in demand.
As such, I don't find any of these companies particularly attractive at these levels, as both trade near the high end of their historical valuations. That being said, I remain in the opinion Costco will continue to provide market-beating returns .
Conclusion
To the disappointment of some market participants, I see no scenario where BJ's Wholesale becomes even close to being Costco. Not in terms of efficiency, nor growth pace, and brand value, and perhaps most importantly, not in terms of the multiple it trades at.
Despite the apparent discount, I don't find BJ's Wholesale attractive at these levels, because it is incomparable to Costco.
With BJ's trading near the high-end of its valuation range, only slightly below its 5-year average, and without any exciting growth prospects, I reiterate the stock as a Hold.
For further details see:
Note To BJ's Wholesale Club Investors: There's Only One Costco