|Source: B.J.s corporate press release|
BJ's Wholesale Club ( BJ) has delivered one of the more disappointing earnings "beats" you'll see, coming off a drop in traffic and membership renewals. The warehouse club chain announced Tuesday that it beat estimates by 3 cents, on earnings of 77 cents per share vs. the consensus of 74 cents. However, nearly 2 cents of the beat came from lower bonus costs (due to a failure to meet internal goals), and 3 cents came from a lower share count. Excluding lower bonus costs, operating income would have actually declined. Highlights of the quarter included a 12% gain in private brand sales and strength in fresh food. My biggest bone to pick with BJ's is the declining traffic. In the fourth quarter, traffic dropped by 3%. In 2005, membership renewals dropped 1% for both business customers and consumers. The company recently instituted a $5 membership fee increase, which could further negatively affect renewals. Traffic has declined on a monthly basis since August, and, not surprisingly, merchandise sales have also been tracking negatively. The chart below shows the trend of same-store sales (excluding gas) and traffic. It says everything you need to know about BJ's. Management's goals for 2006 are to correct those trends. The company will put more resources into advertising, including newspapers and television, to draw traffic. It also hopes to create more of a
"treasure hunt" feel to its stores, something for which rival Costco ( COST) is well known. Another one of the remedies that BJ's hopes to incorporate is a wider variety of quality and price points for general-merchandise items. The CEO seemed especially enthusiastic about his company's offerings of 1,000-thread-count sheets and patio furniture. The strategy makes sense. And while management certainly said the right things, I'm skeptical that it will be able to execute. This management team has done little to earn my confidence up to this point. An example of poor execution is the company's ProFoods Restaurant Supply venture.
Management has typically been quiet about ProFoods, claiming it's an early-stage experiment and that it needs time to gain traction. On Tuesday's conference call, CEO Mike Wedge acknowledged that ProFoods is not living up to expectations. The white elephant in the room on the conference call was the chatter of a potential leveraged buyout of the company. The CEO said he wouldn't comment on market rumors, but he did remark, "I will say that BJ's is enthusiastic about the business plan that it is currently pursuing and that BJ's management and board of directors are committed to accomplishing that plan." Credit Suisse First Boston's Michael Exstein believes Wedge means what he says. He points to the planned ramp-up of store openings in 2007 (15 to 18 stores vs. 12 to 15 in 2006) as evidence that the company is not looking to sell. The analyst believes that the openings will be a drain on cash flow and make the company less attractive to an acquirer. "A major reason that BJ's could be an attractive LBO (leveraged buyout) candidate is the potential that a financial buyer could reduce new store openings and retrench from unproductive geographies in order to wring out incremental cash flow," he wrote. Exstein went on to note that management's plan to accelerate store openings means that investors need to value BJ's on a more fundamental basis, as opposed to valuing it as a takeover candidate. Credit Suisse First Boston intends to seek investment-banking-related business from BJ's in the next three months. BJ's offered EPS guidance of $1.85 to $1.92, including options. That equates to about $2.00 to $2.07 per share, excluding options. I continue to believe the company will fall short of expectations. The figures that the company offered indicate little to no earnings growth in 2006, as the company earned $1.86 per share in the past year. I still believe my
$24 price target is valid. That gives BJ's a 13 P/E based on my expectations of EPS of $1.84 or less. While that's a somewhat low P/E, it's entirely appropriate for a company that is expected to grow earnings in the single digits for the next few years. Furthermore, the stock is trading near the high of its price-to-book range and price-to-cash-flow ranges over the past three years. The current lofty valuation includes a lot of takeover premium. As Exstein stated, the stock should no longer be valued according to that possibility, as management has made it clear that it intends to execute its plan. Until BJ's proves that it can, the stock should trade lower.