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BJ'S WHOLESALE'S

and again at $31 in

. Now they're $39 and change, having easily topped the broad market's returns since both those stories.

For those unfamiliar with the stores, BJ's is like Wal-Mart Stores' Sam's Club division and Costco Wholesale in that it sells discounted goods everything from colossal bundles of toilet paper and sacks of chicken wings to electronics, swing sets and cruises to fee-paying club members. It's unlike either of those chains in that it's a tiny fraction of their size, is concentrated in Eastern states and is less profitable.

When we last looked at BJ's its earnings were a mess, largely because new management was taking one-time charges to unload underperforming units, like a pharmacy venture. It was also reducing the number of stocked items to improve returns and repositioning items to spur impulse purchases. Something is clearly working. In the company's first quarter, which included most of February, March and April, sales increased 12.3%. More important, "same-store" sales, which exclude newly added stores to gauge whether longstanding ones are improving, surged 9.6%. BJ's sells gasoline, and so rising pump prices make that figure more flattering than it should be. But exclude gas, and same-store sales still rose 6% in the first quarter, compared with less than a 1% increase a year ago. The second quarter is off to an even stronger start. May same-store sales swelled 13.4%, or 6.6% excluding gas.

Strapped consumers are favoring discount chains right now, and so BJ's numbers would fail to impress if it merely matched those of its peers. They don't. In May, Sam's Club recorded a 3.6% same-store sales increase and Costco a 5% one, not counting gas. Also, any chain can boost its same-store sales through overaggressive discounting, so BJ's results only deserve applause if they're boosting profits. They are. In its first quarter the chain produced a 26% rise in net profit. Earnings per share topped Wall Street estimates by a whisker, and have done so by an average of 8% over the past four quarters. Management boosted its guidance for the year to a range of $2.04 to $2.14, a six-cent increase on both ends. During the quarter the company bought back $30 million worth of its stock about 1.3% of itself.

Shares now go for 18 times this year's earnings forecast. That might sound like a full price, but consider two things. First, BJ's subpar operating margins are slowly moving in the right direction. They improved from 1.2% a year ago to 1.3% in the first quarter of this year. The average for discount variety stores, by nature low-margin businesses, is about 3.8%. That suggests that BJ's has more room for improvement than its competitors. Indeed, its per-share profits are expected to increase 18% this year, vs. 14% for Costco.

Second, BJ's price/earnings ratio might not tell the whole story. The company has no debt to speak of, while other chains have borrowed heavily in recent years to buy back stock, leaving their overall value unchanged but flattering their earnings per share. (Share repurchases lower the share count, thereby increasing earnings per share.) Add debt into the equation and BJ's peers look costlier. Costco already goes for 23 times earnings, making a comparison with it moot, and Sam's Club's market value is buried in the overall value for Wal-Mart, so consider a less-direct competitor, Target. It goes for 15 times earnings, a seeming discount to BJ's. But add $17 billion in debt to its market value (while subtracting just over $600 million in cash) and the price/earnings ratio climbs to 21.

BJ's turned up recently in a Takeover Targets screen. It looks for companies whose total purchase price including debt is modest relative to underlying earnings potential, ignoring things like write-downs related to past transactions. It also looks for below-average operating margins, which can be a sign of improvements waiting to be made, and positive free cash flow, which comes in handy to fund turnaround efforts. Eight companies made the cut. Run the screen yourself anytime using SmartMoney's screener and the full list of criteria.

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Data as of June 10, 2008.

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Takeover Targets Screen Recipe

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