Are Warehouse Stores Too Dependant On Membership Fee Income?

by: Robert Zenilman

Rob Zenilman submits: When analyzing discount retail stores, I was surprised to find out how dependant warehouse stores were on membership fee income. As a sector (on Yahoo), discount & variety stores are sporting a TTM P/E of 20.0. Costco's (NASDAQ:COST) P/E is almost dead-on with the sector at 20.7, and BJ's Wholesale Club (NYSE:BJ) trails at 14.78. Both Costco and BJ's require customers to purchase annual membership fees between $45-$100. For the 12 months ending with 2006's second quarter, these fees accounted for 72.7% and 83.9% of operating income for Costco and BJ's, respectively.

The following chart summarizes trailing 12 month & forward P/E ratios for key discount retail stores:

Both Costco & BJ's have kept membership fees as a percentage of total revenue remarkably flat (and similar to each other) over the past 2 years:

As I alluded to before, the ratio of membership to operating income is significant:

As you can see, BJs relied entirely on membership fee income for operating profits in 2004-Q4, 2005-Q2 and 2006-Q2.

For the 12 months ending with 2006's second quarter, Costco's membership fee revenue was 72.7% of operating income and BJs was 83.9%. BJs has already reported Q3 numbers - the TTM ratio went up 4.5% to 88.4%

Both warehouse stores offer two levels of membership, lets call them standard and premium. Customers with premium membership get 2% back on their purchases. For standard membership, BJs charges $45, and Costco charges $50. For premium, its $80 and $100, respectively.

This past May, Costco raised their standard membership from $45 to $50. This is expected to add $75mm in annual revenue. If we add this to the last TTM membership fee revenue, Costco's ratio of membership fee revenue to operating income increases from 72.7% to 77.5%.

All thing being equal, this opens the door for BJs to boost its operating income by raising its annual membership fees, currently $5 and $15 cheaper than Costco's (for standard and premium, respectively).

Comment: With BJs recent weakness, there is speculation how it will fit into Eddie Lampert's Sears Holdings (NASDAQ:SHLD). Costco recently warned on earnings, but that might just be a temporary blip.

See: Costco's Q2 earnings conference call transcript.