Wal-Mart (NYSE:WMT) is the largest retailer in the world with close to $450 billion in annual revenues.  About 85% of the retailer’s sales come from its typical big box stores in the U.S. and international markets. However, Wal-Mart also operates 620 warehouse stores under the brand Sam’s Club, in 47 states of the U.S. and Puerto Rico. 
In fiscal 2013, Sam’s Club generated about $57 billion in sales and $3 billion in membership income. While Sam’s Club accounts for close to 12% of Wal-Mart’s revenues, its value contribution to the stock is just 5% due to lower margins. Although this contribution seems insignificant, Sam’s Club is a different business proposition, which has been successful in the U.S.
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 low prices. 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 that of Costco (NASDAQ:COST). The retailer typically charges $40 for individual members and $35 for business members annually. 
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 of 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. 
Warehouse Structure Gaining Popularity
Warehouse clubs, a $390 billion industry, started with the idea of providing goods at lower costs and building a loyal customer base.  Major warehouse clubs such as Costco (NYSE:COST) and Sam’s Club started generating promising results immediately. Costco reached $1 billion in revenues within its first three years, and Sam’s Club crossed $12 billion in annual revenues within 10 years of its inception.  
Some consumer reports have suggested that buyers can save up to 55% when shopping at warehouse clubs.  Moreover, these clubs provide an enjoyable shopping experience as they keep on introducing new products, brands and varieties from time to time.  As a result, while the U.S. general merchandise store sales increased by 47% during the period of 2001-2011, warehouse clubs saw their sales jump by more than 130%. 
We believe that due to these attractive bargains, warehouse clubs are likely to perform well irrespective of the economic conditions. Since a significant number of warehouse clubs’ customers are small businesses, better economic conditions will encourage bigger purchases. On the other hand, tough economic environment can still provide an incentive to shoppers to buy in bulk from warehouse stores to get more discounts. This is why both Costco and Sam’s Club registered positive revenue per square feet growth in the recessionary environment. 
Where Does Sam’s Club Stand In Terms Of Competition?
The U.S. warehouse club industry comprises of only three main players – Costco, Sam’s Club and BJ’s wholesale club. Costco is the strongest of the lot with more than 50% market share, and has grown its revenues faster than Sam’s Club over the past few years. However, there are a few points where we believe that Sam’s Club might have a competitive advantage over Costco.
Sam’s Club offers membership at a lower rate of $40, compared to $55 and $50 by Costco and BJ’s respectively.  While executive members pay $110 at Costco to avail the 2% rewards program, Sam’s Club’s plus members pay $100 for similar benefits. Moreover, Sam’s Club (620 stores) has a wider reach in the U.S. as compared to Costco (450 stores).
Since both the retailers earn more than 50% of their revenues from groceries, there is a potential risk factor that gives Sam’s Club a slight edge over Costco – food price inflation. With the rising food prices, retailers can either increase their product prices or absorb the costs which can affect their margins. Compromising on margins will be relatively easier for Wal-Mart compared to a pure warehouse retailer such as Costco. (see Rising Food Prices and Razor Thin Margins Are A Bad Combination For 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.
Sam’s Club’s contribution to Wal-Mart’s overall revenues has increased marginally over the past five years. In fiscal 2013, same store sales of Sam’s Club increased by 4.1%, whereas the figure was 2% for Wal-Mart U.S. stores.  Although Sam’s Club is still a long way from making a material contribution to Wal-Mart’s stock, it provides the retailer a warehouse business model to compete with Costco on the latter’s turf.
Our price estimate for Wal-Mart stands at $80, implying a premium of about 5% to the market price.Notes:
- Wal-Mart’s SEC filings [↩] [↩] [↩] [↩] [↩] [↩]
- Best Warehouse Store: BJ’s, Costco or Sam’s Club?, Yahoo Finance, Jan 6 2013 [↩] [↩]
- Priced to grow: How Costco got started, CNN Money, Aug 19 2009 [↩]
- Warehouse store showdown: Should you join Costco, Sam’s Club, or BJ’s?, The Christian Science Monitor, Jan 5 2013 [↩] [↩]
- Companies’ SEC filings [↩] [↩]