Key Trends Driving Costco’s $110 Value
Costco (NASDAQ:COST) is the largest warehouse club in the U.S. with around 439 locations, and it has a total of 608 including international ones. A warehouse club business structure enables the customers to buy products at heavy discounts, and in turn, the retailer charges an annual membership fee. Costco faces direct competition from Sam’s Club and BJ’s Wholesale Club. It also faces a stiff competition from other physical retailers such as Wal-Mart (NYSE:WMT) and Target (NYSE:TGT), and online retailers such as Amazon (NASDAQ:AMZN). Despite this competition, the retailer has done reasonably well in the recent past and its latest earnings demonstrated a substantial increase in revenues. Here we discuss some key factors that will drive Costco’s growth in the future.
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Focus On Increasing Penetration Of Executive Membership
Executive members, who account for about 60% of the sales and who also pay a higher membership fee in the range of around $110 while other members pay around $55, are the most valuable to Costco. [1] Executive members tend to have higher renewal rates than other members. The executive membership penetration is on an upward trend and has increased from about 23% in mid-2007 to about 38% in 2012. [1]
Increasing Penetration Of Private Label Merchandise
Costco has invested significantly in developing its premium private label brand, Kirkland Signature, and it plans to increase its penetration to about mid to the high 30 percentile range. The penetration of Kirkland Signature products is higher in the U.S. stores than in international markets.
Though private label brands have higher margins, they tend to be cheaper than their counterparts. Higher margins can be attributed to an enhanced control of sourcing costs, quantity and quality. The increasing penetration of private label brands can slightly improve Costco’s low gross margins.
Competition Intensifying In The Retail Industry
The retail business has become highly competitive. Costco competes with over 800 warehouse club locations across the U.S. and Canada. It faces stiff competition from Wal-Mart, Target and Kohl’s in the general merchandise retail segment. However, most of Costco’s customers are the ones buying in bulk, and they will find more discounts at Costco rather than Wal-Mart and Target.
With the growth of online retailers such as Amazon and eBay (NASDAQ:EBAY), the competition has led to competitive pricing which in turn, has led to a fall in prices and gross margins. However, Amazon enjoys the low price advantage in electronics segment which constitutes about 60% of its sales along with general merchandise. [2] On the other hand, 50% of Costco’s revenues come from groceries and only 16% from the electronics and other hardlines. [1] Hence, the turf on which Costco and Amazon compete is somewhat narrow.
Shifting Trend To Wholesale Shopping
As U.S. shoppers are looking at ways to save money due to the sluggish growth in the economy and a high unemployment rate, warehouse clubs such as Costco and Wal-Mart’s Sam’s Club seem to be viable options. This trend has resulted in an increase in the traffic and subsequently, an increase in the membership which is likely to continue in the future. At the end of fiscal 2012, Costco reported an increase of 2% in the new membership sign up and 11% increase in the membership fee. [1] Moreover, there was a slight improvement in the membership renewal rate as well. These figures indicate that the consumers are shifting towards warehouse clubs.
Our price estimate for Costco stands at $111, implying a premium of about 15% to the market price.
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