A Snapshot of Wal-Mart’s Sam’s Club

Wal-Mart (NYSE:WMT) is the largest retailer in the world with close to $450 billion in annual revenues. ^[1] The retailer operates its typical big box stores in the U.S. and international markets, which account for about 90% of its overall revenues. However, Wal-Mart also operates 611 (as of fiscal 2012) warehouse stores under the brand Sam’s Club in 47 states of the U.S. and Puerto Rico. ^[1]

In fiscal 2012, Sam’s Club generated $54 billion in revenues and $6 billion in gross profits. While Sam’s Club accounts for close to 12% of Wal-Mart’s revenues, its value contribution to the stock is just 5%, according to our estimates, due to lower margins. Although this contribution seems insignificant, Sam’s Club adds a different business proposition, which has been successful in the U.S. amid a weak economic environment.

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How Does Sam’s Club Make Money?

Sam’s Club, like other warehouse clubs, charges a membership fee to its customers and gives them the opportunity to buy goods at the lowest prices in the market. As a result, Sam’s Club’s gross margins are significantly lower than Wal-Mart stores’ margins. We estimate Sam’s Club’s gross margins to be around 11%, similar to those of Costco (NASDAQ:COST). The retailer typically charges $40 for individual members and $35 for business members annually. ^[1]

Since Sam’s Club offers discounts on its merchandise, it attempts to make up for it via a membership fee. However, a warehouse club’s true value lies in its ability to attract bulk buyers. Thus, despite low margins, these clubs generate a significant amount of dollar profits due to a rapid turnover of inventory. Such a value proposition is lucrative to customers who tend to buy large amounts of merchandise and thus, despite paying a membership fee, save money due to discounts.

Sam’s Club offers a variety merchandise categories such as grocery and consumables, home and apparel, and health and wellness. Grocery and consumables account for more than half of Sam’s Club’s revenues. ^[1]

Limited Direct Competition Exists

Sam’s Club has limited direct competition from Costco and BJ’s Wholesale Club, with Costco being the strongest of the lot. Costco’s average revenue growth has been faster than that of Sam’s Club over the past two years even though its revenues are 50% more than Sam’s Club’s. One of the reasons behind Costco’s growth is its private label brands, which have lower prices, higher margins and are comparable in quality to national brands. On this front, Sam’s Club also offers some private label brands such as Member’s Mark, Bakers & Chefs and Sam’s Club.

However, there is one potential risk factor that gives Sam’s Club an edge over Costco – the food price inflation. (see Rising Food Prices and Razor Thin Margins Are A Bad Combination For Costco) The Midwestern drought and global food inflation have resulted in a significant increase in food prices in the U.S. ^[2] Since most retailers generate the majority of their revenues from groceries, they either have to increase the prices or absorb the inflation in their margins. Compromising on margins will be relatively easier for retailers such as Target (NYSE:TGT) and Wal-Mart, but will be difficult for a pure warehouse retailer like Costco. For Sam’s Club, Wal-Mart can utilize its sheer size, higher gross margins and efficient supply chain to better absorb food inflation costs. This can put Sam’s Club in a position to offer food products at attractive prices, which may result in a shift of customers from Costco to Sam’s Club.

Warehouse Structure Gaining Popularity

Due to slow economic growth and persisting unemployment in the US, shoppers are looking for ways to save money. This has driven customers to warehouse clubs such as Sam’s Club and Costco. Even if economic growth picks up, customers may still prefer shopping at Warehouse clubs due to cost benefits as long as they get good quality products. Furthermore, with the improvement in economy, more businesses will emerge and this will drive growth of warehouse clubs.

Significance For Wal-Mart

Sam’s Club’s contribution to Wal-Mart’s overall revenues has increased marginally over the past five years. In Q3 2012, same store sales of Sam’s Club increased by 2.7%, whereas the figure was 1.5% for Wal-Mart U.S. stores. However, the slow growth of Wal-Mart U.S. stores can also be attributed to its huge size as it generates nearly five times Sam’s Club’s revenues. Although Sam’s Club is still a long way from making a material contribution to Wal-Mart’s stock, it provides the retailer a different business model to compete with warehouse retailers such as Costco.

Our price estimate for Wal-Mart stands at $80, implying a premium of about 15% to the market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Wal-Mart’s SEC filings [↩] [↩] [↩] [↩]
2. WRAPUP 2 U.S. Midwest drought worsens, food inflation to rise, Reuters, Jul 25 2012 [↩]