Smile
Investment summary
My previous investment thought on BJ's Wholesale Club Holdings (NYSE:BJ) (published on 29th March) was a hold rating because the valuation was not attractive despite a healthy fundamental outlook. I still find it hard to upgrade BJ to a buy rating because of the valuation trading today, which is expensive relative to peers, and considering my expected EPS growth for the business.
2Q24 results update
Released yesterday, BJ 2Q24 saw total revenue of $5.2 billion (~5% y/y growth), driven by same-store-sales [SSS] growth of 2.4%, which was mainly led by traffic growth. Total gross margin saw 18.4% (~30bps y/y expansion), and this resulted in a 2Q24 gross profit of ~$960 million. However, operating costs did grow faster than topline, at 7.7% y/y, driving total SG&A to $748 million, primarily due to higher labor and occupancy costs. Ultimately, BJ saw an EBIT margin of 3.9%, which equates to ~$203 million, beating consensus estimates by ~$3 million.
Robust demand that is well-supported by the macro environment
This was a solid quarter that reinforces the idea that BJ is well positioned to benefit from this poor consumer spending environment. And we can see this from the strong SSS growth in 2Q24 (2.4%), which marked the 3rd consecutive quarter of acceleration since the -0.1% seen in 3Q23. Importantly, the strength behind this SSS growth was largely supported by traffic (which contributed 400 bps). Also, all product segments saw improvements, which indicate that BJ is attracting customers across the board.
- Perishables, groceries, and sundries saw SSS growth of around 3% and gained share in both units and dollars.
- General merchandise improved sequentially, with SSS growth of >1%.
- Apparel, consumer electronics, and home appliances all saw SSS growth improvements like they did in 1Q24. Notably, apparel saw high-single-digit revenue growth.
I expect BJ to continue seeing very robust demand, as the current consumer spending environment is still largely pressured. As I have written in my post for Yeti Holdings:
but I just cannot get comfortable with the idea that discretionary spending is poor because of the US macroeconomic situation. With consumer confidence still poor and multiple discretionary goods companies sounding the alarm bells
Combined with the comments by other low-cost retailers recently and the fact that large discount stores like TJX Companies and Ross Stores are printing strong SSS growth numbers (4% for both), all of these point to consumers becoming more value-conscious. Indeed, management also noted that demand remains resilient and consumers are value-focused; even higher income levels are trading down (which is a strong signal of consumers pivoting to value buying), as they noted spend per shopper remains healthy at higher income levels.
Spend per shopper remains very healthy at higher income levels and continues to improve at the lower end, especially as we've moved past the tougher lapse related to government aid in the second quarter. 2Q24 earnings transcript
I would also consider the total number of members growing as a good indicator of demand. My view is that consumers sign up as members because they will be visiting the store frequently (be it for the near or long term). In 2Q24, BJ added the greatest number of members since COVID (positive growth on both a sequential and annual basis) and is now tracking to achieve 7.5 million members (the highest number ever for BJ). Also, the fact that the higher tier penetration rate went up to 39% for the first time since the past 6 quarters also suggests a positive change in consumer expected BJ visit frequency (logically, you sign up for the higher tier because you know you are going to shop more, which gives more rebate).
Membership fee increase is a potential upside
As I said previously, the best way to get a sense of whether BJ will raise its membership fees is by tracking what other industry players are doing. I listed Costco (COST) as a good benchmark. Just to recap, BJ has not raised prices for the past 5 years (since Jan'18) and the total number of members has grown from ~5 million to near 7.5 million today, so any increase is going to have quite a sizeable impact on y/y growth.
Coincidentally, just a few months after my last post, COST announced their plans to hike annual fees from $60 to $65 (after 7 years), and this new pricing will take effect on September 1st. This implies an ~8.3% increase. I believe this is a very positive sign that BJ may follow in due time, albeit this was not incorporated into the 2H24 guidance (management mentioned they remained comfortable). While we do not know the exact timing, we know this is likely to happen, especially now that there is a strong precedent. If BJ were to increase by the same dollar amount ($5), this would generate >$30 million in additional membership fee income (~30% growth), which is ~4% of FY23 adj EBIT.
Valuation
Redfox Capital Ideas
While I appreciate the robust fundamental outlook, like I did previously, and I have adjusted my model to reflect this (EPS growth to normalize back to 6% in FY25, minimally, as it benefits from the current uncertain macro environment and an easy comp in FY24), BJ's valuation remains the key hurdle for me when I think about upgrading the stock to a buy rating. Relative to my post in late March, BJ's valuation has gone even higher to ~20x today (from 19x back then), which, I think, is still too expensive considering the expected earnings growth (the S&P Index is expected to grow EPS at 10% over the next 12 months but only trades at 21x forward PE) and where peers are trading. For reference, similar peers in the industry such as Five Below, Dollar General Corp., Target Corp., and Dollar Tree trade at an average multiple of ~16x and are expected to see similar tailwinds.
Hence, I am sticking to my hold rating, purely because the valuation is still not at an attractive level that I can accept.
Conclusion
My view for BJ is a hold rating. Despite the strong 2Q24 results and positive demand outlook, I maintain a hold rating due to its relatively high valuation. While the company benefits from the current consumer spending environment and has seen strong growth in membership and overall sales, its valuation remains expensive relative to the S&P expected EPS growth and peers' valuation.
