In Part One of this Deep Dive, we provide an overview of the warehouse-club sector.

Transcription

1 May 29, 2017 In Part One of this Deep Dive, we provide an overview of the warehouse-club sector. The 40-year-old global warehouse club sector is estimated to generate approximately $191 billion in revenues in The clubs business model seeks to limit gross profits so as to offer low prices to members while generating profits for shareholders through reasonable membership fees. The majority of the clubs are located in the US, which accounted for nearly three-quarters of sector revenues in The market is dominated by three companies: BJ s Wholesale Club, Costco Wholesale and Sam s Club (a division of Walmart). The US warehouse club sector grew at a 7.2% CAGR from 2001 through Its growth rate outpaced that of the total US retail industry by 3.3 percentage points over the period. The international market grew at an even brisker 10.8% CAGR. Yet the sector s growth rate slowed over the same period, actually hitting zero in And researchers are forecasting that the US segment will grow at a 2.4% CAGR, more than 1.5 points lower than overall retail, from 2016 through The spoiler behind the sector s decelerating growth rate has likely been e-commerce, which the clubs have been slow to embrace. Warehouse clubs currently generate 4% or less of their revenues from e-commerce. As is the case with many other retailers, warehouse clubs need to develop a strategy to compete with e-commerce players, as well as leverage their unique strengths to adapt to other demographic and technological changes. 1

2 Table of Contents May 29, 2017 Deep Dive: Warehouse Club Stores About This Deep Dive... 3 Executive Summary... 4 Warehouse Club Companies at a Glance... 6 Sector Overview... 7 Historically Strong Growth and Outperformance... 7 Sector Inflection Point in Warehouse Club Characteristics Conclusion

3 About This Deep Dive Fung Global Retail & Technology is publishing its Deep Dive: Warehouse Club Stores Time to Take the Treasure Hunt Online in three installments. The Executive Summary outlines the spectacular rise of the sector over its 40-year history. From humble beginnings, warehouse clubs have grown into beloved shopping destinations for their members, who enjoy low prices as well as the chance to be surprised and delighted as they go on a treasure hunt through the stores. Yet the industry is at a crossroads, characterized by slowing growth, demographic changes, and the challenges presented by the convenience and appeal of e-commerce. Part One Overview: Sector Overview Part One of the report discusses the historical strong growth and performance of the warehouse club sector, its heavy concentration in the US and the top three companies in the space. The analysis reveals that the sector hit an inflection point in 2015 and has experienced a slowing growth trend in recent years that market researchers expect to continue through The warehouse club sector features a unique business model, where membership fees are the primary contributor to profits and large volumes offset ultraslim margins. While the majority of warehouse club members are individual consumers, small businesses are also an important component of membership. Warehouse clubs growth has exceeded that of department stores and grocery stores. E-commerce, however, accounts for a smaller percentage of sales in the sector than it does for other retail sectors and the US retail industry overall. The sector is led by Costco, the largest club by revenue. Part One concludes with an analysis of warehouse clubs by region. Part Two Overview: Warehouse Club Advantages and Challenges Part Two of the report examines the advantages and challenges warehouse clubs face. The clubs benefit from economies of scale and their broad product mixes, which attract shoppers. They provide significant value pricing to their customers, a treasure hunt shopping experience that offers unexpected surprises and bargains, and a focus on organic products. Retailers such as Costco are located in the prosperous top third of the Weinswig Retail Hourglass, a model that illustrates how companies operating in the midmarket get squeezed. Challenges the warehouse clubs face include shifting shopper preferences due to generational and demographic changes, the steady encroachment of e-commerce, and Amazon s entry into multiple areas of commerce. Part Three Preview: 10 Topics for Retail, Company Profiles and International Overview Part Three discusses 10 topics affecting the warehouse club sector and retail in general: the changing grocery shopper, e-commerce, mobile commerce, robotics in retail, private labels, the sourcing revolution, ancillary products and services, US market saturation, international expansion, and the brief independence of Jet.com. Part Three concludes with profiles of the top three US warehouse clubs and an analysis of the attractiveness of selected global markets. The Fung Global Retail & Technology team hopes that you will find this Deep Dive interesting and informative! 3

4 May 29, 2017 Deep Dive: Warehouse Club Stores Executive Summary Warehouse club stores have had a great run in the 40 years since 1976, when Sol Price founded the first Price Club, which ultimately became today s Costco. The clubs were initially open only to business customers, but later allowed employees of nonprofit and government organizations to join, and eventually opened to the public. The clubs had a unique business model limiting profitability so as to pass the savings on to customers and making the bulk of their profits from membership fees. Customers love the clubs low prices, the ability to buy in enormous quantities and the delight of finding unexpected bargains in treasure hunts throughout the stores. There are not many stores in which customers can purchase a 20 lb. package of steaks, a flat-panel T and a diamond engagement ring all in one trip. The warehouse clubs have successfully leveraged postwar demographics, generally situating themselves in suburban areas with high median incomes and many small businesses to serve, offering consumers in those areas the convenience they need. While shoppers in such areas tend to be affluent, everybody loves a bargain, so many well-off consumers shop the warehouse clubs along with their more price-conscious neighbors. 4

5 The clubs popularity has shown up in their financials. From 2001 through 2016, US warehouse club revenues grew at a CAGR of 6.2%, outpacing the 3.0% annual growth rate of the overall retail industry by more than three percentage points. The sector s growth outside the US was even more brisk over the same period, averaging 10.8%. Profitability did not suffer, either. Despite the clubs vow to limit gross margins in order to offer attractive prices, the top three US warehouse clubs generally have seen operating margins of around 2% 4%. Despite this prosperity, growth has slowed over the past 15 years, and global growth ground to near zero in 2015, making it an inflection point. Now, the US segment is forecast to grow annually at about 2.4%, less than half a point higher than the total retail industry. The slowdown can be attributed to changes in demographics and the ways people shop and, of course, to the steady growth and encroachment of e-commerce. In 2016, e-commerce accounted for 8.1% of US retail and grew by 15.1% year over year. What should the warehouse clubs do to recapture their previous appeal to consumers and reignite the growth rates of years past? Clearly, e-commerce is part of the answer. Among the major warehouse clubs, e-commerce s share of sales is likely highest at Costco, where the channel accounts for 4% of revenues. One short-lived but interesting player in the e-commerce field was Jet.com, which Walmart acquired in Jet attempted to combine the low prices of warehouse clubs with the convenience and ease of e-commerce and m-commerce. The company also implemented some innovative ways to reduce shipping costs. The warehouse clubs need to leverage their unique strengths, which include providing high-quality goods at low prices and providing customers with a treasure hunt experience, as well as offering strong private-label brands. Costco s Kirkland Signature private label accounts for about one-quarter of the company s sales, making it a $30 billion brand. Kirkland Signature products are available on Amazon.com and Jet.com, and the label is arguably a major international brand in its own right. Warehouse clubs also need to adapt to the changing demographic patterns of American suburban life. Members of younger generations are increasingly living in cities rather than in suburbs. In urban areas, living space and storage are at a premium, and many urban dwellers do not own a vehicle that they can drive to a warehouse club and fill with large, bulky purchases. To meet these consumers needs, warehouse clubs should explore offering more of their goods in smaller quantities online and also explore delivery methods that e-commerce companies are using, such as click-and-collect and expedited shipping. In this deep-dive report, we offer an overview of the warehouse club sector, analyze the key factors that are influencing the sector and profile the major players, as well as provide suggestions on what warehouse clubs can do to recapture the strong growth they saw in previous periods. 5

6 May 29, 2017 Deep Dive: Warehouse Club Stores Warehouse Club Companies at a Glance Figure 1. Selected Metrics for the Big Three US Warehouse Clubs, 2016 Category BJ s 1 Costco 2 Sam s Club 3 Financial Net Revenues (USD Bil.) $15.0 $119.6 $57.4 YoY % Change 4.0% 2.5% 0.9% E-Commerce s Share of Revenues (Last FY) N/A 4.0% 2.8% * Membership Fee Income (USD Mil.) $270 $2,683 $1,348 Gross Margin 16.5% 13.8% 16.0% Operating Profit (USD Mil.) $294 $4,211 $1,671 Operating Margin 2.0% 3.5% 2.9% Membership Number of Members (Mil.) Percent Business 25% 55% 20% Percent Consumer 75% 45% 80% Avg. Annual Household Income (USD) $59,600 $74,000 $45,000+ Membership Fee Basic/Premium (USD) $50/$100 $55/$110 4 $45/$100 Avg. Annual Membership Fee Revenue per $25 $32 $23 Member (USD) 5 Stores Number of Clubs US and Puerto Rico Number of Clubs International Number of Clubs Total Total Store Area (Mil. Sq. Ft.) Average Store Size (Thous. Sq. Ft.) Products Number of SKUs 7,000 4,000 6,000 Number of Private-Label SKUs Number of Private-Label Brands Other Avg. Sales per Club (USD Mil.) $70 $168 $87 Avg. Sales per Sq. Ft. $637 $1,168 $659 Avg. Sales per Employee (USD Thous.) $571 $554 $497 Avg. Sales per Member (USD) $1,362 $1,405 $970 *For parent company Walmart Source: Company reports/emarketer/us Census Bureau/Fung Global Retail & Technology 1 BJ s was acquired by several private equity firms on September 30, The company s last public filing was for the fiscal year ended January 2011; all subsequent figures are estimates. 2 Figures for Costco in this report are calendarized (Costco s fiscal year ends August 31), unless otherwise noted. 3 Figures for Sam s Club consider the fiscal year as having ended in December of the prior year. 4 Costco announced that, effective June 1, 2017, the membership fee for all US and Canada Gold Star (individual), Business and Business addon members will rise to $60, and that membership fees for Executive members in the US and Canada will rise to $ Average fee revenue is below the membership fee due to free memberships (e.g., Costco provides a free household card with all paid memberships). 6 Sam s Club s international stores are reported under Walmart s International segment. 6

7 Sector Overview Historically Strong Growth and Outperformance Total revenues for global warehouse clubs are estimated to hit a record $191 billion in 2017, according to Euromonitor International. The sector posted an exceptional CAGR of 7.2% in the US over the 15-year period from 2001 through 2016, and Euromonitor predicts that the global sector will grow at a 4.1% rate from 2016 through Figure 2. Global Warehouse Club Sector Revenues (USD Bil.) $250 $200 $150 $100 $ E 18E 19E 20E Source: Euromonitor International/Fung Global Retail & Technology 7

8 May 29, 2017 Deep Dive: Warehouse Club Stores The warehouse club market is largely a US-centric phenomenon. The US represented 73% of the global market in 2016, but Euromonitor expects the country s share to decrease to 68% by The warehouse club market is largely a US-centric phenomenon. The US represented 73% of the global market in 2016, but Euromonitor expects the country s share to decrease to 68% by Figure 3. Share of Global Warehouse Club Revenues, by Geography 16% 17% 18% 20% 20% 21% 2% 2% 8% 2% 2% 8% 2% 8% 2% 8% 9% 9% 74% 73% 72% 70% 69% 68% E 18E 19E 20E US Brazil Mexico Other Source: Euromonitor International/Fung Global Retail & Technology Costco is the largest international warehouse club operator, with stores in Australia, Canada, Japan, Mexico, South Korea, Spain, Taiwan, the UK and the US. Sam s Club operates warehouses in Brazil, China and Mexico as well as the US. Apart from the big three US clubs (BJ s, Costco and Sam s Club), there are just a handful of other players in the sector. Cost-U-Less operates 13 stores in the Caribbean and South Pacific. Makro Cash & Carry Belgium is a cash-and-carry retailer operated by Germany s Metro Group. Finally, PriceSmart is the largest operator of membership warehouse clubs in Central America and the Caribbean. The predicted change in share within a growing market means that the warehouse club sector is growing faster in other geographies than it is in the US. Euromonitor predicts that the global market will grow at a 4.1% CAGR through 2020 and the US market at a 2.4% CAGR. Figure 4. Est. Warehouse Club Market Growth, by Geography, E (CAGR) 12% 10.8% 10% 8% 6% 4% 8.4% 8.0% 6.3% 6.1% 4.1% 2.4% 2% 0% China Other Brazil Mexico UK World US Source: Euromonitor International/Fung Global Retail & Technology 8

9 In the US, the sector is dominated by Costco, which represents about 65% of the market and generates more than twice the revenue of its nearest competitor, Sam s Club. In the US, the sector is dominated by Costco, which represents about 65% of the market and generates more than twice the revenue of its nearest competitor, Sam s Club. Figure 5. Big Three Warehouse Clubs: Estimated Revenue (Left Axis, USD Bil.) and Market Share (Right Axis, %), 2016 $140 62% 70% $120 60% $100 50% $80 40% 30% $60 $ % $40 $20 $57.4 8% $15.0 Costco Samʼs Club BJʼs 20% 10% 0% Figures are in US dollars, converted based on year-over-year exchange rates. Source: Euromonitor International/Fung Global Retail & Technology In addition, the sector has remained nicely profitable, with the big three US players posting solid and growing profits in recent years. Figure 6. Big Three Warehouse Clubs: Annual Operating Income (USD Bil.) $7 $6 $5 $4.9 $5.2 $5.5 $5.7 $6.2 $4 $3 $2 $ Costco Samʼs Club BJʼs Source: Company reports/bloomberg/national Retail Federation (NRF)/Kantar Worldpanel/ Fung Global Retail & Technology 9

10 May 29, 2017 Deep Dive: Warehouse Club Stores Sector Inflection Point in 2015 The warehouse club sector has enjoyed many years of strong growth, and it appears to have many more years of growth ahead of it. But as the graph below shows, sector revenue growth was 4.0% in Figure 7. Global Warehouse Club Revenues (USD Bil.) $ E CAGR: 4.1% $200 $ CAGR: 7.2% $100 $50 The warehouse club sector growth slowed over the period, even hitting nearzero growth in E 18E 19E 20E Source: Euromonitor International/Fung Global Retail & Technology The figure below shows that warehouse club sector growth slowed over the period, even hitting near-zero growth in Figure 8. Global Warehouse Club Sector Growth Rate 16% 14% 12% 10% Trend 8% 6% 4% 2% 0% E 18E 19E 20E World US Source: Euromonitor International/Fung Global Retail & Technology 10

11 Warehouse Club Characteristics Warehouse clubs sell paid memberships to consumers and small business customers that provide access to a wide selection of goods, often in bulk, at discounted prices in largestore formats. Business Model Warehouse clubs sell paid memberships to consumers and small business customers that provide access to a wide selection of goods, often in bulk, at discounted prices in large-store formats. Grocery products are a major driver of foot traffic, but shoppers can purchase everything from apparel to appliances to seasonal goods to eyeglasses at warehouse clubs. At the heart of the warehouse club business model are memberships and economies of scale. The clubs large membership bases enable them to purchase items from suppliers in large volumes at low cost, which, in turn, helps them attract more members. Clubs can price products with just enough markup to cover costs and operating expenses and, in some cases, a sliver extra to contribute to the bottom line. At their inception, warehouse clubs sold items geared toward small business owners, generally the more affluent demographic in a region. As the business model evolved, the clubs added great-quality merchandise at bargain prices for nonbusiness use, and the treasure hunt aspect of shopping in the clubs, which delights consumers, gained traction and became integral to the clubs operations. Today, general consumers represent a greater portion of the clubs membership base than business owners do. The warehouse club sector has enjoyed resilient growth through most economic cycles, offering value pricing on brand-name staples and discretionary luxuries when the economy stalls, as well as high-end items that appeal to shoppers in a robust economy. On a recent trip to warehouse stores in Connecticut, our team found items available from a variety of well-known brands, including Bose sound systems, Apple ipads and iphones, Charisma sheets, Dockers khakis, Speedo swimsuits and Fitbit activity trackers. While Costco had luxurious diamond rings for sale at $16,999, Sam s Club offered an aspirational handbag collection featuring Coach, Kate Spade, Michael Kors and Tory Burch. In addition to wellpriced national brands, warehouse clubs are increasingly offering private-label items and ancillary services that range from gas stations to pharmacies. BJ s, Costco, Sam s Club the Big Three The US, which comprises the majority of the global warehouse club market, is home to three main warehouse club companies, known as the big three: BJ s, Costco and Sam s Club (a division of Walmart). Figure 9. Big Three Warehouse Clubs: Revenues, 2016 (USD Bil.) $140 $120 $100 $80 $60 $40 $20 $119.6 $57.4 $15.0 Costco Samʼs Club BJʼs 11

12 May 29, 2017 Deep Dive: Warehouse Club Stores While sales per member drive revenue at warehouse clubs, membership fees are what expand profits. Over time, membership revenue exceeds net income and accounts for a substantial portion of pretax operating profits. Membership Fees Are the Main Profit Driver While sales per member drive revenue at warehouse clubs, membership fees are what expand profits. Over time, membership revenue exceeds net income and accounts for a substantial portion of pretax operating profits. We estimate that total membership fees contributed 70% of the big three s operating income in Figure 10. Big Three Warehouse Clubs: Operating Income Breakdown, 2016 (USD Mil.) $5,000 $4,000 $3,000 $4,211 $1,528 $2,000 $1,000 $1,671 $2,683 $326 $1,345 $294 $270 Costco Samʼs Club BJʼs Membership Fees Other Operasng Income $24 At Costco, membership fees exceeded net income every fiscal year from 2004 through 2016, and fell within a range of 69% 86% of operating income, averaging 75% during the period. Given the importance of membership fees, attracting and retaining members is a priority for the company. In fiscal 2016, Costco s renewal rate was 90% in the US and Canada and 88% worldwide. Costco runs on lean operating margins to ensure member savings, and leads the sector in sales per member. The company generated 45% higher sales per member than Sam s Club did in Costco also maintains a large and growing membership base that drives profits. Figure 11. Big Three Warehouse Clubs: Merchandise Revenue per Member (Left Axis) and Membership Fee Revenue per Member (Right Axis), 2016 $1,600 $1,400 $1,405 $32 $1,362 $40 $35 $1,200 $1,000 $970 $23 $25 $30 $25 $800 $20 $600 $15 $400 $10 $200 $5 Costco Samʼs Club BJʼs Revenue per Member Average Membership Fee per Member 12

13 In fiscal year 2016, Costco had the highest membership of the big three warehouse clubs and only about 11% of its members had explicit business accounts. In fiscal year 2016, Costco had the highest membership of the big three warehouse clubs and only about 11% of its members had explicit business accounts. Figure 12. Big Three Warehouse Clubs: Member Composition, FY16 (Mil.) BJʼs Costco Samʼs Club Costco - Gold Star Costco - Household Members Costco - Business Members BJ s and Sam s Club figures are estimates. In recent years, Costco and Walmart (serving here as a proxy for Sam s Club) both saw flattish growth in the percentage of their revenues deriving from e-commerce. E-commerce accounts for a lower share of both companies sales than it does for the overall US retail industry: in 2016, e-commerce accounted for 8.1% of all retail sales in the US, and grew by 15.1% year over year. Figure 13. Costco and Walmart: E-Commerce s Share of Sales 4.5% 4.0% 4.0% 3.5% 3.0% 2.5% 3.0% 3.0% 3.0% 2.1% 2.5% 2.8% 2.0% 1.7% 1.5% 1.0% 0.5% 0.0% FY13 FY14 FY15 FY16 Costco Walmart Source: Company reports/internet Retailer/Fung Global Retail & Technology 13

14 May 29, 2017 Deep Dive: Warehouse Club Stores Although the figure above shows that Costco leads Walmart in terms of e- commerce revenue as a percentage of sales, the figure below shows that Walmart leads substantially in terms of e-commerce revenue in dollar terms. Walmart completed its acquisition of online retailer Jet.com on September 20, 2016, and a recent article published on tech news website Recode estimated Jet s annual revenue at about $500 million. Figure 14. Costco and Walmart: Online Sales Totals (USD Bil.) $16 $14 $12 $10 $10.0 $12.2 $13.7 $8 $7.7 $6 $4 $3.1 $3.3 $3.4 $4.6 $2 Macroeconomic factors, including disposable income, employment and consumer sentiment, affect warehouse club membership growth. Currently, economic conditions in the US favor the sector. FY13 FY14 FY15 FY16 Costco Walmart Source: Company reports/internet Retailer/Fung Global Retail & Technology Membership Composition Is Key Macroeconomic factors, including disposable income, employment and consumer sentiment, affect warehouse club membership growth. Currently, economic conditions in the US favor the sector. Unemployment continues to decline and consumer sentiment has increased. Locating stores in geographic areas likely to enjoy economic growth and withstand downturns is the key for increasing and sustaining club membership. Costco s US locations are in states that are more affluent than its competitors stores are, and BJ s has clusters of stores in affluent states. The locations of these stores likely benefit the companies. The majority of warehouse club members are consumers, but small businesses are also an important component of membership. The number of small businesses in the US grew by 1.7% between 2010 and 2014, and it is likely to increase as the US economy grows. Costco commands the largest percentage of business members among 14

15 the big three warehouse clubs. In a strong economy, this is an advantage, but falling demand from small business customers in a weak economy could slow the chain s growth. Figure 15. US: Small Business Data Number of Small Businesses 5,717,302 5,707,941 5,806,382 % Change (0.2)% 1.7% Employment by Small Businesses 54,996,680 56,062,893 57,894,592 % Change 1.9% 3.3% 2014 data were released on September 29, Source: US Census Bureau Sector Performance The US continues to dominate the warehouse club sector, as it is the only international market with a substantial number of major club chains. The US continues to dominate the warehouse club sector, as it is the only international market with a substantial number of major club chains. The US is also the only major economy whose statistics office routinely reports sector data for warehouse clubs. These sector data are bundled with data on predominantly nonfood supercenters, such as those operated by Walmart. In this section, we examine figures for both the warehouse club sector and the warehouse club and supercenter sectors combined. Costco has led the gains in the US sector. In five years, the company gained more than two percentage points of share of the broader, combined warehouse club and supercenter sector. Figure 16. Big Three Warehouse Clubs: Share of Warehouse Club and Supercenter Sales 25% 20% 17.2% 18.0% 18.2% 18.9% 19.3% 19.7% 15% 13.9% 13.9% 13.6% 13.4% 12.9% 13.0% 10% 5% 3.1% 3.1% 3.1% 3.2% 3.3% 3.4% 0% BJʼs Costco (US) Samʼs Club Source: Company reports/us Census Bureau/Fung Global Retail & Technology 15

16 May 29, 2017 Deep Dive: Warehouse Club Stores In the face of competition from discount channels, Internet pure plays and specialists, some nonspecialized retail sectors are faltering The Warehouse Club Sector Has Enjoyed Robust Growth In the face of competition from discount channels, Internet pure plays and specialists, some nonspecialized retail sectors are faltering. Warehouse clubs, though, remain strong, even compared with rival grocery and department stores. Figure 17. US: Sector Sales for Warehouse Clubs and Supercenters, Department Stores, and Grocery Stores (USD Bil.) $700 $600 $500 $400 $300 $200 $ Warehouse Clubs and Supercenters Department Stores Grocery Stores Source: Company reports/us Census Bureau/Fung Global Retail & Technology Based on US Census Bureau data, grocery was the fastest-growing sector of the three in 2016, with sales increasing by 2.3%, followed by warehouse clubs and supercenters, which grew by 0.6%. The department store sector declined for the eleventh consecutive year in 2016, shrinking by 3.1%. 16

17 The figure below breaks down the big three warehouse clubs combined revenue in terms of domestic and international sales. Sales in both market segments grew from 2012 through Figure 18. Big Three Warehouse Clubs: Combined Annual Sales (USD Bil.) $200 $180 $160 $140 $120 $100 $80 $60 $40 $20 $191.9 $186.3 $187.8 $176.6 $170.1 $32.6 $31.5 $32.4 $30.2 $28.1 $142.0 $146.4 $153.8 $156.3 $ US Internasonal Revenue growth for the big three warehouse clubs was much lower in 2015 than in the immediately preceding years, and international growth uncharacteristically lagged that of the US in 2015, largely owing to declines in Brazil and Mexico. Revenue growth for the big three warehouse clubs was much lower in 2015 than in the immediately preceding years, and international growth uncharacteristically lagged that of the US in 2015, largely owing to declines in Brazil and Mexico. Figure 19. Big Three Warehouse Clubs: Total Sales Growth 16% 14% 13.5% 12% 10% 8% 7.5% 7.2% 7.9% 6% 5.0% 4% 2% 3.1% 1.6% 2.1% 2.6% 0% (2)% (4)% (3.1)% US Internasonal 17

18 May 29, 2017 Deep Dive: Warehouse Club Stores Warehouse Club Growth Exceeds Supercenter Growth From 2012 through 2016, US warehouse club revenues grew at a 3.0% CAGR, while revenues for supercenters grew more slowly, at a 1.7% CAGR. Historical Results From 2012 through 2016, US warehouse club revenues grew at a 3.0% CAGR, while revenues for supercenters grew more slowly, at a 1.7% CAGR, we estimate, based on US Census Bureau data. Figure 20. US Warehouse Clubs and Supercenters: Revenues (USD Bil.) and CAGR $500 $450 $400 $350 $300 $250 $200 $150 $100 $50 $433.3 $440.2 $442.7 $406.3 $419.3 $264.3 $272.9 $279.5 $283.9 $283.1 $142.0 $146.4 $153.8 $156.3 $ CAGR 3.0% 1.7% 3.0% US Warehouse Clubs Supercenters Source: Company reports/us Census Bureau/Fung Global Retail & Technology In terms of percentage of total US retail sales (excluding gasoline and auto parts), the warehouse club and supercenter combined sector remained flat from 2012 through 2016, whereas the big three warehouse clubs gained just 0.2 percentage points of share. Figure 21. US: Sector Sales as a Percentage of Total US Retail Sales 14% 12% 11.9% 12.0% 12.0% 12.2% 11.9% 10% 8% 6% 4% 4.1% 4.2% 4.2% 4.3% 4.3% 2% 0% Warehouse Clubs and Supercenters Big Three Warehouse Clubs Source: Company reports/us Census Bureau/Fung Global Retail & Technology 18

19 Recent Results In March 2015, Costco announced that isa would replace American Express as the company offering its rewards credit card beginning April 1, 2016, putting an end to a 16- year business relationship. This transition negatively impacted Costco s fiscal first-quarter 2016 earnings by $15 million, or.02 a share During the 2016 calendar year, Costco posted revenues of $119.6 billion, up 2.5% year over year. Comparable store sales for the year excluding gasoline increased by 2.8%. Consensus estimates call for revenues of $126.7 billion in fiscal year 2017, up 6.7%, and for EPS of $5.91, up 10.9%. In its fiscal second quarter of 2017, Costco reported a total comp increase of 3%, comprising a 3% increase in the US, an 8% increase in Canada and a 2% decrease in other international regions. In fiscal 2017, Costco plans to open eight new warehouses, five in the US and three in Canada. In March 2015, Costco announced that isa would replace American Express as the company offering its rewards credit card beginning April 1, 2016, putting an end to a 16-year business relationship. This transition negatively impacted Costco s fiscal first-quarter 2016 earnings by $15 million, or.02 a share. By the end of fiscal 2016, nearly 85% of 11.4 million American Express cards had been transferred and activated, and 730,000 new members had activated their cards; these figures were ahead of the company s internal expectations. In fiscal 2017, Sam s Club reported revenues of $57.4 billion, up 0.9% year over year. In the year, comparable store sales increased by 0.2% including fuel and increased by 1.1% excluding fuel. For the fourth quarter of fiscal 2017, Sam s Club reported comp sales growth (excluding fuel) of 2.4%. Including fuel, comps increased by 3.1%. In October 2016, an SEC filing disclosed that Walmart had increased its stake in Chinese e-commerce company JD.com after selling its stake in the Yihaodian online marketplace to JD.com in June. In its fiscal third-quarter 2017 earnings call, Walmart announced that its Sam s Club flagship store had launched on JD.com s website, offering hundreds of millions of customers access to Sam s Club s products with same-day and next-day delivery service. 19

20 May 29, 2017 Deep Dive: Warehouse Club Stores The Competitive Landscape As stated earlier, the warehouse club sector is highly concentrated. There are only three big players, all of which are US-centric and headquartered in the US, which accounts for more than 70% of sector revenue, and concentration is likely to remain high given the substantial capital needed for new entrants or other rivals to be able to compete with these sector leaders. Nonetheless, warehouse club chains face heavy competition from each other and from other retail verticals, including specialty hardline, drugstore, department store, mass merchant and Internet retailers. Costco is the leader of the big three warehouse clubs in terms of total sales, US sales and sales per store. Its scale is due in part to its substantial international presence, but high-volume, lowmargin and limited-line trading is the company s formula for success. Revenues and Growth: Costco Leads the US Market Costco is the leader of the big three warehouse clubs in terms of total sales, US sales and sales per store. Its scale is due in part to its substantial international presence, but high-volume, low-margin and limited-line trading is the company s formula for success. The big three recorded an estimated total of $192 billion in revenues in 2016, up 2.2% from the prior year. Costco drove the sector s growth in the year; the company s $3.0 billion of growth exceeded an increase of.6 billion at BJ s and an increase of.5 billion at Sam s Club. A drop in Sam s Club revenue in 2015 stemmed from a near-30% decline in the company s gasoline revenue, which decreased to $4.5 billion from $6.4 billion in the prior year, primarily due to lower fuel prices. Sam s Club s revenues excluding gas increased by 1.4% in The company s retail square footage increased by 1.2% and its comparable store sales were flattish. Comps weakened during the period across the sector, reflecting tougher trading as the sector moved closer to maturity, if not saturation. Figure 22. Costco and Sam s Club: Comparable Store Sales (YoY % Change) 7% 6.2% 6% 5% 4% 3.8% 4.1% 4.8% 3% 2% 1% 0% (1)% 0.4% 0.5% 0.4% 0.6% 0.2% (0.3)% Costco Samʼs Club 20

21 The figure below displays US store revenues and number of US stores for the big three warehouse clubs. Figure 23. Big Three Warehouse Clubs: US Revenue (Left Axis, USD Bil.) and Number of US Stores (Right Axis), 2016 $100 $90 $80 $70 $60 $50 $40 $30 $20 $10 $ $ $15.0 BJʼs Costco Samʼs Club US Revenue US Stores Source: Company reports/nrf/fung Global Retail & Technology The table below lists net US revenues for the big three warehouse clubs. Figure 24. Big Three Warehouse Clubs: Net US Revenues (USD Bil.) BJ s $12.5 $13.0 $13.8 $14.4 $15.0 Costco $73.1 $76.3 $81.9 $85.0 $87.2 Sam s Club $56.4 $57.2 $58.0 $56.8 $57.4 Total $142.0 $146.5 $153.7 $156.2 $159.6 Includes membership fees for BJ s and Costco Source: Company reports/nrf/fung Global Retail & Technology The table below lists net revenue growth for the big three warehouse clubs. Figure 25. Big Three Warehouse Clubs: Net Revenues (YoY % Change) BJ s 5.7% 4.0% 6.5% 4.3% 4.0% Costco 10.9% 5.2% 7.5% 1.8% 2.6% Costco (US only) 9.9% 4.4% 7.4% 3.8% 2.6% Sam s Club 4.9% 1.3% 1.5% (2.1)% 0.9% Total Global 8.4% 3.8% 5.5% 0.8% 2.1% Includes membership fees for BJ s and Costco Source: Company reports/nrf/fung Global Retail & Technology 21

22 May 29, 2017 Deep Dive: Warehouse Club Stores Warehouse clubs compete against specialists such as electronics and toy retailers, generalists such as Walmart and Sears, and Internet pure plays. Warehouse Clubs ersus Other Large General Merchandisers Warehouse clubs compete against specialists such as electronics and toy retailers, generalists such as Walmart and Sears, and Internet pure plays. So, how do the two biggest US warehouse clubs measure up against their primary competitors in terms of sales and growth? In scale, Costco and Sam s Club rival large specialist retailers such as Kroger and Best Buy, respectively. Both clubs also are well ahead of bigname generalists, such as Kohl s, Sears and Dollar General. Compared with many big store-based rivals, such as Walmart, Target, Best Buy and Sears, Costco and Sam s Club have outperformed in terms of revenue growth. Costco grew at a 5.5% CAGR from 2011 through 2016 and Sam s Club grew at a 1.3% CAGR from 2011 through Costco s growth has rivaled Dollar General s, confirming that both have benefited from the polarization in retail that has made discount channels the champion over midmarket players. Figure 26. Selected US Warehouse Clubs vs. Selected US Retailers: Revenues (USD Bil., 2016) and Revenue CAGR ( ) $600 $500 Walmart US $ Revenue $300 $200 Costco Kroger Amazon $100 Home Depot North America Target Best Buy Samʼs Club Sears Toys "R" Us Kohlʼs Dollar General (15)% (10)% (5)% 0% 5% 10% 15% 20% 25% 30% Revenue CAGR Source: Company reports/factset/fung Global Retail & Technology 22

23 Warehouse clubs are inherently a low-gross-margin format: sector profits are driven by volume, even more so than in other forms of mass-market retail. Costco operates on especially lean gross margins, which feed through to ultraslim operating margins that are an inherent part of its value-formoney proposition. Large olume Compensates for Ultraslim Margins Warehouse clubs are inherently a low-gross-margin format: sector profits are driven by volume, even more so than in other forms of mass-market retail. Costco operates on especially lean gross margins, which feed through to ultraslim operating margins that are an inherent part of its value-for-money proposition. Membership fees contribute the bulk of profits. Membership revenues alone contributed 2.2% of Costco s total revenues in fiscal Figure 27. Big Three Warehouse Clubs: Gross Margin, % 16.5% 11.2% Costco Samʼs Club BJʼs Costco s reported and BJ s estimated operating margins generally increased during the period, but Sam s Club s margins declined in 2015 and 2016 due to higher costs from investment in people, payroll, technology, promotions and demos combined with costs for expanded payment options and real estate charges. Figure 28. Big Three Warehouse Clubs: Operating Margins, % 3.5% 3.0% 3.4% 3.3% 3.2% 2.8% 2.9% 2.9% 3.2% 3.1% 3.5% 2.9% 2.5% 2.0% 1.8% 1.8% 1.9% 1.9% 2.0% 1.5% 1.0% 0.5% 0.0% Costco Samʼs Club BJʼs 23

24 May 29, 2017 Deep Dive: Warehouse Club Stores Costco Leads in Sales per Store and Store Size Sales per store is one of Costco s most impressive metrics and helps explain its market leadership. The company s average annual sales per outlet are almost double those of its closest competitor. Sales per store is one of Costco s most impressive metrics and helps explain its market leadership. The company s average annual sales per outlet are almost double those of its closest competitor. Costco said that 165 of its stores generated revenues exceeding $200 million each in fiscal year Of those, two generated revenues of more than $400 million that year. The average Costco store is 7% larger than the average Sam s Club, and much larger than the average BJ s (BJ s reportedly stays small in order to have a higher density of clubs). Costco does benefit from larger store sizes, but that alone does not account for the disparity in sales per outlet between the chains. Because Costco and Sam s Club have close to the same number of stores, on average, Costco s dominance is likely due to its impressive sales density coupled with its larger store sizes. Figure 29. Big Three Warehouse Clubs: Average Store Size (Thous. Sq. Ft.) Costco Samʼs Club BJʼs The average Costco store produces nearly twice the revenue of the average Sam s Club store, and much higher revenue than the average BJ s store. Figure 30. Big Three Warehouse Clubs: Sales per Store, 2016 (USD Mil.) $180 $168 $160 $140 $120 $100 $87 $80 $70 $60 $40 $20 Costco Samʼs Club BJʼs 24

25 Costco is the leader in sales density (i.e., in sales per square foot), despite offering fewer SKUs than either Sam s Club or BJ s, indicating that Costco achieves exceptionally strong sales volume per SKU. This allows Costco to get better buying prices, which it passes on to shoppers. Costco is the leader in sales density (i.e., in sales per square foot), despite offering fewer SKUs than either Sam s Club or BJ s, indicating that Costco achieves exceptionally strong sales volume per SKU. This allows Costco to get better buying prices, which it passes on to shoppers. This is the epitome of narrow-range, deep-discount retailing, and Costco s performance on this measure suggests that rivals (especially Sam s Club) have significant potential to drive up sales densities and boost profitability per store. Figure 31. Big Three Warehouse Clubs: Sales per Sq. Ft., 2016 $1,400 $1,200 $1,168 $1,000 $800 $659 $637 $600 $400 $200 Costco Samʼs Club BJʼs The table below shows that the big three warehouse clubs have been steadily growing their store counts in recent years. Figure 32. Big Three Warehouse Clubs: Store Counts FY13 FY14 FY15 FY16 Mar BJ s Costco Sam s Club US Total 1,455 1,502 1,543 1,583 1,606 25

26 May 29, 2017 Deep Dive: Warehouse Club Stores Number of Product SKUs Does Not Differentiate Offering members wide choice does not really offer a competitive advantage in the warehouse club sector. With fewer product lines than its US rivals, Costco has achieved leadership and impressive growth. Offering members wide choice does not really offer a competitive advantage in the warehouse club sector. With fewer product lines than its US rivals, Costco has achieved leadership and impressive growth. This underscores that Costco sells very high volumes of the SKUs it stocks, which allows the company to buy at very attractive prices. Plus, large stores and limited ranges mean substantial onshelf presence, driving down costs of replenishment. By these metrics, Costco is effectively a hard discounter akin to European grocery discounters Aldi and Lidl, whose ultranarrow ranges and high volumes translate into low prices, and turn wafer-thin margins into a profitable business. Figure 33. Big Three Warehouse Clubs: SKUs and Private Labels No. of SKUs No. of Private-Label SKUs No. of Private-Label Brands BJ s 7, Costco 4, Sam s Club 6, US Warehouse Clubs Have arying Regional Focuses In terms of geography, BJ s focuses primarily on the Northeastern US, while Costco s stores are most common in the Southwest. Sam s Club stores are primarily located in the Southwest, Midwest and South-Central US. The regions with the highest number of stores are highlighted in the table below. Figure 34. Big Three Warehouse Clubs: US Store Distribution, 2016 Region BJ s Costco Sam s Club Total Northeast Southeast Midwest South Central Northwest Southwest Other Total ,384 Conclusion Part One Part One of the report discussed the historical strong growth and performance of the warehouse club sector, its heavy concentration in the US and the top three companies in the space. Part One of the report discussed the historical strong growth and performance of the warehouse club sector, its heavy concentration in the US and the top three companies in the space. The analysis revealed that the sector hit an inflection point in 2015 and has experienced a slowing growth trend in recent years that market researchers expect to continue through Part Two of the report examines the advantages and challenges warehouse clubs face. Advantages include the economies of scale while providing significant value pricing to customers and a treasure hunt shopping experience that offers unexpected surprises and bargains. Challenges the warehouse clubs face include shifting shopper preferences due to generational and demographic changes, the steady encroachment of e-commerce, and Amazon s entry into multiple areas of commerce. 26

27 Deborah Weinswig, CPA Managing Director Fung Global Retail & Technology New York: Hong Kong: China: John Mercer Senior Analyst John Harmon, CFA Senior Analyst Amy Lin Research Assistant Hong Kong: 8th Floor, LiFung Tower 888 Cheung Sha Wan Road, Kowloon Hong Kong Tel: London: Marylebone Road London, NW1 6JQ United Kingdom Tel: 44 (0) New York: 1359 Broadway, 9th Floor New York, NY Tel: FungGlobalRetailTech.com 27