Costco’s Revenues to Grow on Discount Strategy

Costco’s (NASDAQ:COST) average revenue per square foot (RPSF), an important metric to measure retail sale success, grew from around $809 in 2006 to around $814 in 2009. The simple yet effective strategy of providing goods at bulk and for lower prices has been the reason for consistent growth in Costco’s revenues. Costco competes with warehouse club operators like BJ’s Wholesale Club (NYSE:BJ) and Wal-Mart’s (NYSE:WMT) Sam’s Club, in addition to large retailers like Target (NYSE:TGT).

Going ahead, we expect the growth in RPSF to continue, although at a lower pace since Costco is experiencing cannibalization of its existing stores and also because the company is shifting its focus to the international markets from the US market. While we expect Costco’s RPSF will grow to around $828 in 2013 and be stable at that level thereafter, Trefis members expect consistent growth to about $1132 by the end of our forecast period, corresponding to an upside of 18% to our price estimate for COST stock.

Effective Business Strategy Draws More Customers

Costco offers large discount on particular brands and products and, in turn, charges annual membership fee to its customers. Business customers tend to buy in bulk, and hence can make significant savings if they buy at steep discounts from Costco. With this simple strategy, Costco has successfully expanded its customer base, mainly in executive membership which has seen rising penetration from about 23% in mid 2007 to about 29% in mid 2009.

Executive members pay a higher membership fee of $100 (compared to business members who pay $50 annually) and they account for around 60% of total Costco sales and have higher membership renewal rates. As penetration of executive membership increases, Costco’s RPSF for its US stores is likely to increase.

Cannibalization Could be a Threat

Although Costco has low market penetration in North Eastern areas, it faces the threat of cannibalization of its own sales if it has to expand aggressively. The company claims that cannibalization was part of the negative comparable store sales growth in 2009.

Trefis Community Forecast

The Trefis community forecasts that Costco’s revenue per square foot for its stores located in the US will increase from around $960 in 2010 to $1130 by the end of the Trefis forecast period, compared to the baseline Trefis estimate of an increase from $818 to $828 during the same period. The member estimates imply an upside of 18% to the Trefis price estimate for Costco’s stock.

Our complete analysis for Costco’s stock is here.

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