23 July 2018 Retailing / Department Stores & Broadlines BJ's Wholesale Club Deutsche Bank Research Rating Company Date Buy BJ's Wholesale Club 23 July 2018 Initiation of Coverage North America United States Reuters Bloomberg Exchange Ticker Price at 19 Jul 2018 (USD) 25.70 Consumer BJ.N BJ US NYS BJ Price target 30.00 Retailing / Department Stores & Broadlines 52-week range 27.05 - 22.00 BJ’s is Back and Better than Ever Valuation & Risks Mike Baker, CFA Initiating coverage with a Buy rating and $30 price target We are initiating coverage with a Buy rating and $30 target. Positive investment Research Analyst themes include: (1) unique positioning in a favorable industry supports improving +1-617-217-6253 top line; (2) improved processes and platform to drive sales and margin opportunities; (3) growing membership fee income the backbone to future profit Stock & option liquidity data Market Cap (USDm) 3,593.5 gains; and (4) a new club opportunity is also additive to sales. Each of these Shares outstanding (m) 139.8 themes contribute to a compelling long-term financial model, including solid sales Free float (%) 100 from comps, store growth and membership, mid-single-digit profitability gains Volume (19 Jul 2018) 96,880 and mid-double-digit EPS growth. Our price target is based on a target multiple Option volume (und. shrs., 1M avg.) 79,277 that is at a slight premium to peers, with scenario analysis pointing to 2x upside Source: Deutsche Bank versus downside. We see four positive investment themes 1. Unique positioning in a favorable industry supports improving top line: We believe the club industry has among the best fundamentals in retailing and BJ’s is well positioned within the club channel to drive top- line growth. The club sector is taking share from traditional retailers, particularly in grocery, due to a compelling consumer offering, featuring prices 15% to 40% below other channels. Within the club vertical, BJ’s, under new management, has refocused its customer segmentation to increase focus on a more moderate-income family relative to competitor positioning. In addition, BJ’s goes to market with a differentiated mix compared to other club models, skewing more towards grocery and fresh food in an attempt to take share from traditional grocery. Each of these help support a nascent improvement in comp sales. 2. Improved processes and platform to drive sales and margin opportunities: We see a number of areas in which BJ’s, under new management, has revamped its processes, platforms and procedures to operate more efficiently and drive improved comparable store sales, higher profitability or both. These include its "category profitability improvement" program, which has already achieved hundreds of basis points of procurement cost savings, with more to come. In addition, BJ’s still has room to run on its improved private label strategy, and we believe is in the early innings of seeing the benefits of enhanced pricing, promotional and product-assortment strategies, which should contribute to EBITDA margin expansion. Deutsche Bank Securities Inc. Distributed on: 23/07/2018 05:33:09 GMT Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 091/04/2018. 7T2se3r0Ot6kwoPa 23 July 2018 Retailing / Department Stores & Broadlines BJ's Wholesale Club 3. Growing MFI the backbone to future profit gains: The hallmark of the club industry, in our view, is the consistency of the membership fee income (MFI), which supports BJ’s go-to-market strategy and the ability to take market share. Like others in the space, the MFI revenue drops right to the bottom line, enabling the clubs to take share through lower prices and compelling value to customers, while still maintaining visibility into a stable annual cash flow stream, which accounts for about 50% of annual EBITDA. For BJ’s in particular, through our proprietary membership model, we quantify a number of initiatives to improve its membership metrics and drive higher MFI growth. These include programs aimed at growing renewal and retention rates and increasing penetration of higher- tiered memberships, where the company lags competitors. 4. New club opportunity also additive to sales: BJ’s has a leading position in the club channel on the East Coast and particularly in the Northeast, with an opportunity to reinvigorate a new club opening plan that has paused. This should help augment top-line growth, in our view. Similar to other initiatives, we believe a revamped new store opening strategy, implemented by the new management team, should enable low-single- digit square-footage growth annually over the next five years. Sam’s closure of 20 clubs within BJ’s operating states increases our confidence in BJ’s ability to reaccelerate store growth. We believe it will not only lead to top-line growth directly, but should help support comps as new locations mature. Financial outlook shows comp improvement, EBITDA and EPS growth After 3+ years of negative comps, BJ’s has returned to positive growth over the past three quarters and we see that continuing in the 1%-2% range over the next few years. Combined with new club openings and MFI increases, as well as increasing gas sales, we model 4% top-line growth and 6% EBITDA growth over the next five years. Current post IPO leverage is 3.7x, but should drop 0.5x a year, driving EPS growth of 15% annually, making for a solid and consistent earnings algorithm. Price target based on 10x, a slight premium to peer average - sensitivity analysis suggesting 2x upside versus downside BJ’s is trading at 9.8x and 9.2x our 2018 and 2019 adjusted EBITDA estimates of $554mm and $592mm. This compares to the peer average of 10.1x and 9.6x. Our $30 price target is based on 10x our 2019 estimates, a slight premium to the peer average. We believe this is justified based on BJ's higher EPS growth rate. This translates into a P/E of 24.6x and 21.3x our 2018 and 2019 EPS forecasts. Our sensitivity analysis shows $35 to the upside in our bull case and $21 to the downside in our bear case, or up 37% versus down 17%. Some risks to be aware of We see several risks to BJ achieving our target price, as noted in more detail later in this report. These include: (1) comps have underperformed Costco and others; (2) tougher compares ahead; (3) potential margin pressures; and (4) above- average leverage. Page 2 Deutsche Bank Securities Inc. 23 July 2018 Retailing / Department Stores & Broadlines BJ's Wholesale Club Table Of Contents Overview............................................................................. 4 Executive Summary............................................................ 5 Unique positioning in a favorable industry supports improving top.................. 5 Improved processes and platform to drive sales and margin opportu...............5 Growing MFI the backbone to future profit gains............................................. 5 New club opportunity also additive to sales......................................................5 Financial outlook shows comp improvement, EBITDA and EPS growth............6 About The Company........................................................... 7 Background.........................................................................................................7 What has changed?........................................................................................... 8 Positive investment themes driving sales and margi........ 10 Unique positioning in favorable industry supports improving top l................. 10 Improved processes and platform to drive sales and margin opportu............. 14 Growing MFI the backbone to future profit gains........................................... 19 New club opportunity.......................................................................................23 Risks.................................................................................. 27 Comps have underperformed Costco and others............................................ 27 Tougher compares ahead.................................................................................27 Potential margin pressures...............................................................................27 Above-average leverage................................................................................... 28 Lock up expiration 180 days post the mid-June S1 filing................................29 Financial Outlook Shows Comp Improvement, EBITDA a.........................................................................................30 A look back at what went wrong and what went right................................... 30 A look ahead to what we expect.....................................................................33 Long-term earnings algorithm shows solid EBITDA and above-average..........39 A quick look at sensitivity, both positive and negative....................................41 Initiating with a Buy rating and a $30 price targe............ 42 Current valuation reflects big move post IPO.................................................. 42 Our thoughts on the most relevant peer group............................................... 42 Price target derivation based on 10x multiple................................................