Warehouse Clubs Find the Sweet Spot

Costco and BJ's post solid sales growth even as other merchants falter. How have these big-box behemoths sidestepped the retail slowdown?

by Ben Steverman

It's been a tough winter for U.S. retailers with one big exception: Warehouse clubs are busy despite the slow traffic at nearly every other retailer, as new results from Costco Wholesale Corp. (COST) and BJ's Wholesale Club (BJ) showed Mar. 5.

Costco saw same-store sales jump another 7% in February, while its smaller rival BJ's, which focuses on the northeastern U.S., saw same-store sales rise 5.9%.

BJ's and Costco are among the first chains to report February sales, but don't expect other retailers to report similar success. Wal-Mart is expected to post a 1.1% increase in same-store sales, but sales at almost every other major chain are expected to fall, according to analyst predictions compiled by Reuters Estimates.

Target (TGT) should fall 0.3%, while analysts expect a 4.1% decline at Kohl's (KSS), a 2.9% decline at the Gap (GPS), a 1.9% drop at J.C. Penney (JCP) and a 3.0% decline at Macy's (M), Reuters Estimates says.

"Consumers are feeling the heat on a number of fronts," says Ken Perkins, president of Retail Metrics. The full force of a housing slowdown is kicking in. Higher inflation, including rising gas and food prices, is hurting, and many consumers are worried about their jobs as recession fears mount.

At BJ's, Costco and their rival, Sam's Club, which is owned by Wal-Mart, customers buy yearly memberships to get access to food and other goods, ranging from T-shirts to wide-screen televisions, priced at steep discounts.

Warehouse clubs "become more attractive [as] consumers become more price-sensitive," says Georges Yared of Yared Investment Research.

The clubs can avoid some of the broader consumer slowdown by focusing on staples — items like food and home supplies that consumers must buy even if they avoid spending on luxuries.

As Richard Galanti, Costco's chief financial officer, put it to analysts Mar. 5, "People still have to eat."

A certain amount of inflation can also help the discount warehouses, execs and analysts say. First, consumers seek out the clubs' gas, often sold to members at discounted prices. Second, shoppers want to save gas by making fewer shopping trips but buying more with each visit. That makes the warehouse's sales of bulk food attractive to shoppers, Perkins says.

"Where inflation is driving up prices, BJ's helps consumers stay within their budget," Herbert Zarkin, BJ's chairman and chief executive, told analysts Mar. 5.

The strong sales have helped both chain's bottom lines.

On Mar. 5, BJ's posted earnings of 80 cents per share last quarter, up from 18 cents a year ago. While February same-store sales were up 5.9%, last quarter's same-store sales rose 5.4% and total sales were up 1.9%. The chain operates 175 clubs in 16 eastern U.S. states.

"The recovery story is in full swing," wrote UBS (UBS) analyst Neil Currie. Standard & Poor's equity analysts upgraded the stock from "hold" to "buy." (S&P, like BusinessWeek, is a unit of the McGraw-Hill Companies.)

Costco's earnings per share rose 12% from a year ago to 74 cents. That mostly meeting analyst and investor expectations, though some were worried by higher expenses and slightly narrower profit margins.

Costco shares fell 2.5% to 60.83 on Mar. 5. The stock is up 10% in the past year. BJ's shares, up 15% in the past year, moved 6.7% higher on Mar. 5 to close at 35.52.

No one, including BJ's and Costco executives, seem to think the chains are completely insulated from the broader economy or a deep consumer slowdown.

For example, says John Langston, an analyst at Hodges Capital Management, higher gas prices helped Costco's U.S.