It's the same old story
Same old song and dance, my friend.

-- Aerosmith

BJ's Wholesale Club ( BJ) presented at the Citigroup 2006 Small & Mid-Cap Conference at the Mandalay Bay in Las Vegas earlier this week. But investors are better off at the slots, where they'll likely lose only 5% to 12% vs. a more than 20% drop from BJ's current levels, according to my $24 price target .

During its presentation, management rehashed the themes from its Feb. 28 earnings conference call -- increasing traffic, private labels and 1,000 thread-count sheets. While I didn't expect the company's strategy to change from just two weeks ago, management could have been a bit more imaginative when highlighting which items in the store are expected to perform well. With 7,500 different items for sale, you'd think CEO Mike Wedge could find a few different products to talk about other than the sheets, bed in a bag and patio furniture he mentioned on the earnings call.

As I experienced deja vu listening to the presentation, it occurred to me that one of the problems with BJ's is the lack of a focused imagination. The company does announce many new initiatives, such as its Incredible Kids Club, Pro Foods restaurant supplier and 17 private labels. Although BJ's is focused on its fresh-food offerings, it will embark on an expensive advertising campaign designed to entice customers to buy big-ticket items. It seems like BJ's is throwing everything at the wall to see what sticks.

Admittedly, some of it is sticking. Two test stores in Florida are performing well and the increase in private-label products helped lift gross margins by 11 basis points to 8.48% in the 52 weeks ending Jan. 28.

However, compare BJ's to market-leader Costco ( COST), which has a laserlike focus on its current business and a stellar track record for implementing new ancillary businesses that fit in well with Costco's core.

I still can't get my arms around BJ's 17 private labels compared to Costco's one. I'm a fairly regular BJ's shopper. While reviewing a list of its various private labels, I recognized three -- Wellsley Farms, Rozzano and Berkley & Jensen. The latter is the company's flagship private label, similar to Costco's Kirkland brand. It took Costco years to establish Kirkland as a brand that represented quality and value. I believe Berkley & Jensen is on the same path. But diluting the private label with 16 other brands will confuse shoppers and extend the length of time it will take to entice them to change their established buying patterns.


Advertising could make or break BJ's year. The company has enjoyed success with a direct-marketing campaign in which it sends coupons to consumers. It will continue with this method, sending coupons for big-ticket items like televisions.

The company will also engage in a newspaper and TV campaign in an attempt to drive traffic. Warehouse clubs tend to shy away from costly advertising methods such as TV. Despite audiences that are becoming more and more fractionalized, TV can still be an effective branding tool. However, it's a risky proposition that could have a negative impact on margins and profitability. A call to BJ's asking for budgetary details for these campaigns was not returned.

Like all grocers, BJ's has been ramping up its fresh-food offerings. It has also smartly reduced the package size of some of its food products. One of the knocks of buying in bulk is that sometimes you just don't need five gallons of potato salad. By selling some food items in smaller sizes, BJ's is likely to capture incremental sales that may have been made at a traditional grocery store. The higher margins of fresh food are an important reason behind the company's emphasis on the segment.

While fresh food has been the highlight of recent quarters, general merchandise has performed miserably. The category's sales decreased 2% on a same-store sales basis in the past year. In April, the company will send out a general merchandise direct-mail piece to members. The mailer will have coupons for high-ticket items in electronics, TVs and furniture, to name a few. If the campaign is successful, not only could it improve BJ's' performance, it might set the table for future promotions.

But that's a big "if." BJ's does not have a history of wowing customers with its merchandise offerings. On the fourth-quarter conference call, Wedge stated, "We are clearly focused to improve our general merchandise offerings, to improve our treasure hunt." This is one area where rival Costco excels.

Last, and most important, is traffic (or the lack thereof). Traffic growth has not been positive in 11 months. In other words, fewer people are walking into stores open at least a year. That is a critical statistic. In a low-margin, high-volume business like warehouse retail, traffic growth is vital to improving margins and earnings.

BJ's management didn't simply wake up at the end of the fourth quarter and realize it had to to address this problem. It has been attempting to combat the negative traffic growth for months, to no avail. Some of the new initiatives make sense; however, this is not a management team that gets the benefit of the doubt, not after the dismal performance over the past year.

I continue to believe the stock should be sold at current levels.
In keeping with TSC's editorial policy, Lichtenfeld doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86, 87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback; click here to send him an email.