The Discount and Variety Retailing Industry

Luis Madariaga

ACC-321

Dr. R. Hurley

THE DISCOUNT AND VARIETY RETAILING INDUSTRY

PART I - INTRODUCTION AND FINANCIAL ANALYSIS

A. Industry & Company Profiles

In this segment of the retail industry, companies offer members, who pay an annual fee, a limited selection of products and services. Facing competition from discounters, such as Target that do not charge a membership fee, firms in this industry are continuously expanding their offerings to include additional products and services such as food, optical departments, insurance, gas stations and new and used car purchase programs, among others. Warehouse clubs eliminate many of the costs associated with traditional distribution channels by purchasing full truckloads of merchandise directly from manufacturers and storing it on the sales floor. This study analyses the two the largest stand-alone companies in this segment that are solely focused on the warehouse club industry segment.

Costco Wholesale Corporation

Costco was founded in 1983, went public in 1985 and in 1993 merged with Price Club, a successful membership warehouse. With over 400 membership warehouse stores serving more than 38 million members, Costco is now the largest wholesale club operator in the US.

BJ's Wholesale Club, Inc.

In 1984, after the success of Price Club and with the increased presence of Wal-Mart's Sam's Club, the owner of retail chains TJ Maxx, Hit or Miss and HomeClub, Zayre Corporation launched BJ's. With a total of 140 warehouses in 16 states, BJ's is the third largest warehouse club retailer in the US behind Costco and Sam's Club.

B. Financial Statements

Costco's fiscal year ends on the Sunday nearest the end of August. The financial statement analysis is based on their latest 10-K filing as of September 1, 2002, as well as subsequent quarterly SEC filings. BJ's latest fiscal year ended on February 1, 2003 and the financial statement analysis is based on their latest 10-K filing.

Income Statement

For their latest fiscal year, Costco reported total revenues of $38.7 billion, an 11% increase over prior year. Year over year, their gross profit grew by $580 million, a 14% increase, to $4.8 billion. Net income also increased by 14% from $602 million to $699 million. BJ's generated revenues of $5.9 billion showing a 12% increase from the previous year. Their gross profit grew by $38 million, a 6% increase, to $628 million and net income increased by 6% to $130 million from prior year. Despite their differences in size, both companies are showing strong revenue growth above the industry average of 7% ("Media"). BJ's has reported a profit margin of 2.2%, which is better than Costco's 1.8%. But BJ's profit margin has shown some volatility going from 2.7% in 2000 to 1.5% in 2001.

Although Costco's net income increased by an impressive 14% while BJ's could only achieve a 6% growth in net income year over year, one would tend to think that Costco, being much larger than BJ's, should be able to achieve better margins. One of the reasons this has not been so is that Costco has been aggressively opening new warehouses, whose expense ratios to sales are higher than at mature warehouses. This effect can also be witnessed by the fact that although costs as a percent of total revenue declined by 0.3 points to 87.6% ($33.9 million), selling, general and administrative expenses (SGA) as a percent of total revenue increased by slightly more than 0.3 points to 9.2%. Costco grew during this period from 345 to 374 warehouses, including overseas operations in Mexico, Canada, UK, South Korea, Taiwan and Japan. BJ's SGA expenses as a percent of revenue had been steadily declining since 1999 from 7.8% to last year's 6.6%. They are now at 6.7% due mainly to expense increases related to new warehouses as well as an unfavorable effect of lower than planned club sales. BJ's opened 13 new stores but closed 3 existing locations.

Balance Sheet

Costco increased cash by $200 million to $805 million during this period. Over $1 billion came from operating activities of which most went to fuel their expansion activities. Accordingly, merchandise inventory increased by 14% to $3.1 billion and makes up 27% of total assets. Net PPE, at $6.5 billion, makes up 56% of total assets. Long-term