Description

BJ’s is a $2 bn retailer with a clean balance sheet, potential for growth, trading at 7.2x EV/EBITDA.  Given aggressive investment banks have been issuing commitment letters for 7-8x Debt/EBITDA in the retail space, this is one of the few companies in the public market that could literally be purchased with debt.  While this is a perpetual LBO target, we also believe that the exit of Mike Wedge (former CEO) increases the chance of a turnaround in the business.  Under an LBO, we believe BJ’s could be worth $36-$38.  Given a turnaround, the stock should trade easily into the mid-forties.

 BJ’s is a warehouse club chain that operates 165 stores, primarily on the East Coast, which sell food and general merchandise items.  Like it’s competitors Sam’s Club and Costco, BJ’s charges its customers a membership fee and offers lower prices than other channels by stocking a limited number of SKUs, purchasing directly from manufacturers, minimizing advertising expenditures, streamlining distribution, and operating large, spartan stores where inventory is stored in palettes directly on the sales floor. 

 BJ’s has a unique position in the industry, being substantially smaller than both of its competitors, and the only one that is regionally focused.  However, unlike being a CC competing against a BBY, or ODP competing with SPLS, BJ’s is actually a market leader in New England, not a small competitor struggling against the category killer.  That said, BJ’s is not without certain issues.  BJ’s has a horrible general merchandise team, which consistently does a poor job purchasing items that are a value proposition to its members: for instance, how many people do you know really want to buy neon pink lawn chairs?  Mike Wedge, the now former CEO, aggressively pursued a questionable strategy.  He decided to orient BJ’s towards the individual customer, and therefore increased the amount of food sold and dramatically increased the number of SKU’s.  The average BJ’s now has 7500 SKU’s, while its competitors range for 4,000 to 5,500.  The higher margin food SKU’s compensated for the increased SG&A associated with handling more inventory, allowing BJ’s to maintain its margins the last couple of years.  This strategy, however, resulted in the alienation of BJ’s small business customers and disguised some of the poor general merchandise trends we see today.

 Why with all of these issues are we recommending this stock to VIC?  In essence, the departure of Mike Wedge in November (former CEO) allows the current interim CEO (and the incoming CEO when chosen) to address these issues.  Rather than being married to the strategy, the interim CEO (and obviously the CEO to come) is looking at the business with fresh eyes.  Unlike many retailers with problems, this is not a concept that is broken.  In fact, the warehouse club space is continuing to grow, and take share from other retailers.  BJ’s, even with its troubles, is still showing sales growth of over 8% this year.  Also, BJ’s has no operational issues.  The company’s systems are all centrally controlled, with an extremely effective distribution system.  As the management team likes to proclaim, BJ’s stores operate leaner than anyone else in the industry.  Therefore, their problems are in essence, solely due to poor merchandise.  A reasonably talented merchant could increase store productivity significantly in a year, and at the current multiple of 7.2x, you aren’t even paying an expensive price for the current business.  To give you an idea of the potential increase in productivity, BJ’s has sales/sq foot of $450, significantly lower than that of Costco ($950) or Sam’s Club ($550).  Bringing BJ’s sales/square foot to Sam’s level could increase your EBITDA by at least 30%.

BJ’s merchandising efforts are inferior to those of its competitors in segmentation and quality and BJ’s store organization fails to imbue the “treasure hunt” mentality of its competitors.  BJ’s also has a lower penetration of higher-margin private label products than other warehouse clubs.  Private label products are much higher margin, which would also help BJ' s profitability going fowards.

 In many ways, BJ’s is an attractive private equity candidate, and with both an interim CEO and CFO, this would be an excellent time for the board to authorize a sale of the company.  It trades at a low absolute multiple (7.2x LTM EBITDA) and is valued considerably below Costco, it’s only publicly traded comparable (10x LTM EBITDA).  BJ’s owns the real estate for about a third of its stores, which we believe provides a value backstop of about $10 per share, assuming no value for the ongoing business.  Income is relatively stable given its backed by membership fees from a relatively stable community.  Due to its warehouse-like stores, the company requires minimal maintenance capital expenditures, estimated by the company to be about $40 mm/year, with the remainder of its cap ex going into new stores.  You will note in the valuation below that the EBITDA-CAPEX multiple does not seem to indicate this as a value play.  However, at 8.7x EV/(EBITDA-CapEX) you can get an idea as to the amount of  free cash flow that is generated if new store openings are slowed  by a new CEO.

 The membership fees derived from its historically stable membership base generate the majority of the company’s EBITDA, providing a largely recurring revenue stream.  The renewal rate each year runs about 87% for a business and approximately 83% for an individual membership.  In a bad year, renewal rates might drop by 30-50 bps, so the membership levels are fairly stable.  The company recently increased its membership fee by $5, which should guarantee its some growth for the next couple of quarters (it takes one year to fully cycle a membership increase).  This stability of earnings should make the company relatively easy to lever.  In addition, the ability to completely cut cap ex if necessary is rare in retailers…no one really needs to freshen up the appearance of a warehouse.

 A private equity buyer would also see significant opportunity to rationalize SKU counts, bring in outside merchandising talent, increase private label penetration, and recruit and motivate a high quality management team.  In addition, a private equity firm would likely see opportunity in developing an improved store expansion plan, expanding penetration of in-store services such as pharmacies, and rationalizing underperforming locations.  A buyer may also be able to reduce corporate headquarters and other G&A expenses, which are high relative to similar retailers.

 
Valuation

We believe that under an LBO, assuming an exit of around 7x EBITDA, and leverage of 6.0x EBITDA, you could easily get an offer of $36/share with a low twenties IRR.  As many of the PE seem to be bidding and levering much more aggressively than that, assuming 7x debt to EBITDA will get you a price more in the $38 range.  Given a turnaround in the business and assuming a 9.0x multiple (slight discount to Costco), would get you $45/share. 

Risks

• Poor holiday performance
• Restructuring results in a decrease in earnings
• Current management is questionable.  There are a lot of positions open.

Catalyst

• announcement of a new CEO
• Potential increase in share buyback
• Potential announcement of a sale process

Catalyst