RealMoney Silver - Shop for a Bargain at BJ's

Shop for a Bargain at BJ's
By Bill Trent
RealMoney.com Contributor
4/15/2008 3:29 PM EDT

Rising prices and a slowing economy are hurting most retailers, and last week's retail sales results show that consumers are favoring discount stores. I think BJ's Wholesale Club (BJ) may be the way to play this trend. Based on its relative value compared to Costco (COST) , BJ's' stock could rise between 25% and 40% over the next year or so.

BJ's same-store sales rose 6% in March, compared to a 7% rise at rival Costco. Wal-Mart (WMT) eked out a modest gain, while Target (TGT) and Family Dollar (FDO) saw declines.

Over the last year, BJ's has significantly underperformed Costco. The promotion of longtime employee Laura Sen to the position of president and chief operating officer in January, however, may have answered investor concerns regarding CEO succession. Since then, the stock has been catching up to Costco, though there remains 15 percentage points of differential performance that could be made up.

BJ's has 177 stores, clustered primarily in the Northeast and Florida. The company tries to differentiate itself by offering both bulk quantities and smaller, supermarket-sized portions of many products. It is also the only warehouse club that accepts all manufacturers' coupons, which may be an important differentiator in the current shopping environment.

Analysts appear to agree. Since January, estimated earnings per share for the current fiscal year have risen from $1.94 to $2.03. In the last 60 days, estimates for the fiscal year ending in January 2010 have risen from $2.13 to $2.22. In that time, estimates for Costco have been essentially unchanged. As a result, even though BJ's shares have been performing better than those of its rival during that time, its forward P/E of 17.9 times remains well below the 20.5 multiple enjoyed by Costco.

Although analysts project faster growth from Costco, further estimate revisions would likely have analysts rethink their growth estimates for BJ's. The earnings are now expected to grow 14% this year (after adjusting for nonrecurring benefits in 2007), which is closer to Costco's long-term growth estimate than the 9.4% currently projected for BJ's. Narrowing the difference between expected growth rates should also narrow the difference in P/E ratios.

At Costco's forward P/E multiple, BJ's could trade at $45.50 by this time next year, which would amount to a 25% increase.

The comparison is more favorable still on a free cash flow basis, even though BJ's cash from operations in the 2008 fiscal year benefited from a rise in accounts receivable relative to inventory that is probably unsustainable. After allowing for that, I estimate the cash from operations to be $250 million.

After deducting $90 million for capital expenditures, sustainable free cash flow was $160 million, which amounts to a 7.4% free cash flow yield, a substantial premium to the 2.6% yield currently available from five-year Treasury bonds. Costco's free cash flow yield, meanwhile, was just 2.5% of market capitalization over the last 12 months.

Given that comparison, I don't think it would be unreasonable for BJ's to yield 5.2%, which would still be a 100% premium to Treasuries and to Costco's free cash flow yield. At a 5.2% free cash flow yield, BJ could trade at $51.50, a 42% increase from the current market price.