WHOLESALE SLAUGHTER Fierce competition may bring shakeout in warehouse stores

THE BALTIMORE SUN

Wholesale clubs have gone from warehouse to doghouse.

Once hailed for their merchandising muscle, the sprawling members-only stores have staggered through several months of flabby sales. Stock prices in the major wholesale club companies have plummeted, and analysts have vied to see who can cut earnings estimates fastest and deepest.

Skeptics see the slide as an indication the concept was overrated from the start. They note that a counterattack by the nation's grocers has slowed the clubs' drive for food sales. So-called "category-killers," stores that specialize in office supplies, computers or other merchandise, are chewing into more product lines.

Meanwhile, fast-growing warehouse stores, which already have moved into the most fertile markets, face increasing competition from other wholesale clubs -- and from stores in their own chains as well. "All players want to position themselves to be in the good markets," said Otto Grote, retail analyst for Derby Securities in New York.

The result, analysts predict: a shakeout that could cut the number of major wholesale club chains from five to two or three.

A look at the trading record of the major wholesale club stocks reflects the gloom. Since the industry's glory days last fall, it's been wholesale slaughter on Wall Street.

* Price Club (82 stores, $7.3 billion in sales for fiscal year that ended in September), the San Diego-based company that pioneered the concept in 1976, has seen its stock slide to $29 a share Friday from $43.75 since Nov. 6.

* Costco Wholesale Corp. (89 stores, $5.5 billion for fiscal year that ended in August), the Seattle-based company that many analysts call the best operator in the industry, fell from $41 a share in January 1992 to $17.875 Friday.

* Waban Inc. (39 stores, $1.8 billion for fiscal year that ended in January), the Natick, Mass.-based chain whose BJ's Wholesale Clubs are gaining the tightest grip on the Baltimore market, plummeted in value from $25.75 a share last May to $12.875 Friday.

The slump is also hitting the discount retailers that operate warehouse chains.

Last month, Moody's Investors Service cut its rating on Kmart's long-term debt, citing poor prospects for earnings and sales growth at the company's 114-store Pace Membership Warehouse subsidiary as one reason. Moody's also downgraded the debt of Pace, which had $4.4 billion in sales for the fiscal year that ended in January.

Even Wal-Mart Stores Inc. has been hurt by weak sales at its Sam's Club division, whose $12.3 billion in sales at 256 stores accounted for more than 20 percent of Wal-Mart's $55 billion in revenue in the fiscal year that ended in January.

Since March, Wal-Mart's stock has fallen from $34 to $27.25 -- a 20 percent decline for a company that has barely recognized any direction other than up. Sam's is not entirely to blame, but it has contributed to the decline.

But these are not the agonies of a contracting industry. "This industry is in a full-out maximum expansion mode," said Mr. Grote.

Nationwide, wholesale clubs are in a race for real estate. Each of them want to be the first to put a membership card in the wallets of people like Henry H. Holder III.

Mr. Holder, who operates a tractor-trailer training company, emerged from the Price Club in Glen Burnie last week with a cart full of merchandise for his home and business. He's a loyal Price Club customer, even though a newer BJ's has just opened in Pasadena, closer to his home.

"I just don't want to spend an extra $25 or $30" for another membership, he said.

BJ's President Herb Zarkin is familiar with that sentiment.

"If you're the second one in and you don't bring anything new to the party, why should I leave the first guy?" he said. He said the Pasadena store is doing "OK," but not nearly as well as BJ's White Marsh store, which was the first in that area.

L But rapid expansion carries heavy costs. Open a conventional

store and the business will be in full swing within a year or two. Open a warehouse club and it might take five years before the store can build a membership base big enough to pay off, said Mr. Grote.

The rush to grab the best locations has led to fierce competition, and not just among different chains. BJ's for instance, will divert some business from its Pasadena and White Marsh stores when it opens stores in Columbia and Owings Mills next month -- becoming the first wholesale club to ring the city.

This strategy takes a toll on a chain's same-store sales figure -- a closely watched gauge that tracks sales at stores that have been open at least 12 months. BJ's same-store sales, for example, fell 9.7 percent in April after declines of 10.4 percent in March and 8.4 percent in February.

Cannibalization of existing stores is only one reason for those declines, Mr. Zarkin notes.

Poor weather, especially the March blizzard, hit BJ's hard because of its concentration in the Northeast, he says. And the wholesale clubs' members had less to spend from income tax refunds this year because of changes in the federal withholding tax system, he adds.

Another factor in declining sales: deflation in the price of food and other items, Mr. Zarkin says. He ticked off some examples: the 39-ounce can of Folger's coffee that BJ's sold for $4.22 a year ago, now $3.22; computers that once sold for $2,000, now on sale for $1,100.

But even as government reports signal that food price inflation is resuming, competition among the five big chains is increasing. Through most of the 1980s, they concentrated on markets where they could be the first to open a club. Now, with little virgin territory left, they are increasingly going head to head.

"The easy share has been taken," said Eapen Chacko, retail analyst with Dain Bosworth in Minneapolis.

For a typical retail chain, the obvious strategy would be to cut margins and beat rivals on price. But gross margins in the wholesale club industry are already razor-thin -- about 8 percent compared with 35 percent for a typical retailer.

That leaves merchandising skills -- as well as the race to market -- as the biggest factors in the increasingly brutal competitive environment. Little things, such as knowing that the predominantly German residents of upstate New York prefer white hot dogs, can make all the difference, says Mr. Zarkin.

Some retail analysts think the warehouse club industry's problems won't be solved simply by fine-tuning the merchandise mix. For one thing, the clubs' increasing emphasis on food has sparked a fierce competitive response from grocery chains.

Barry Scher, Giant Food's vice president of public affairs, says the Landover-based grocer instituted its SuperDeals bulk-purchase program two years ago to counter the clubs.

Mr. Scher said he's confident that the threat from the warehouse clubs has abated. "They can't sustain themselves," he said. "How many times do you have to go in and buy a 48-can case of ravioli?"

MA The grocers' counterattack suggests that the warehouse clubs'

problem could run deeper than a few months of poor same-store sales.

"The industry has lost direction a little bit," Mr. Chacko said. "What are people going to really think of their stores for? Food was a big thing, and now the food is starting to erode."

Some analysts believe the industry needs to emphasize the small-business customers who were the clubs' earliest constituency.

"The warehouse clubs started to woo the individual shopper, and I think the novelty wore off," said Linda Morris, retail analyst for PNC Financial Corp. in Philadelphia. "They really do need to start focusing on the entity that comes in and spends several $H hundreds of dollars a week rather than the individual who spends several hundreds of dollars a year."

Pace, Kmart's entry in the warehouse wars, is poised to take that advice, says spokesman Doug Hock. But B.J.'s Mr. Zarkin doesn't see it quite that way. He plans to pursue

the general consumer market aggressively.

In reality, it's hard to separate the two. Out of a half-dozen consumers interviewed at the Glen Burnie Price Club, all but one operated small businesses. And they shopped there for the home as well as the business.

If these buyers are any indication, the warehouse clubs have a strong base of satisfied customers. All spend heavily on each visit.

"I call it my $100 Price Club because it never costs less than $100,"said Dick Chase, who lives in Baltimore and operates a bed-and-breakfast inn on the Eastern Shore.

He is just one of millions of reasons that Mr. Grote, the Derby analyst, is confident that the warehouse clubs' earnings will "explode" in two or three years.

"They will do unbelievable amounts of business and they will take it away from all sorts of competitors," he said. ". . . This category is the most dynamic in the retail industry today."

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