Articles for Costco

Costco’s October Growth Beats Estimates As Consumer Confidence Improves

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Monday, November 10th, 2014 by

Warehouse giant Costco (NASDAQ:COST) recently reported its October sales results that turned out better than the consensus estimates. The retailer’s overall comparable sales increased by 4.0%, while analysts were expecting 3.6% rise in this metric. In the U.S., comparable sales growth for the four week period stood at 6%, but it remained flat in international markets mainly due to the negative impact of currency fluctuations. Excluding the impact of gasoline price deflation and foreign exchange, comparable sales in the U.S. and international markets increased by 7% and 6%, respectively. Overall, the company’s net sales grew by 7% to $8.73 billion, concluding another month of good performance. Growth in the company’s revenues can be attributed to a healthy rise in new membership signups along with store expansion. Amid an uncertain economic environment in the U.S., the warehouse shopping model has become very popular among buyers looking for cost-saving deals. Being the strongest warehouse retailer in the U.S., Costco has been customers’ first choice, which is evident from its growing member base. For several quarters now, the company has registered a rise in its membership renewal rates and new membership signups.

Our price estimate for Costco stands at $130, implying a discount of about 5% to the current market price.

See our complete analysis for Costco


Historically, Costco has generated the bulk of its comparable sales growth from an increase in number of members, which appears to be the case in October as well. While the company does not provide details related to its member base on monthly basis, we will consider the increase in number of members from Q4 fiscal 2013 (the quarter that ended before July 2013) to Q4 fiscal 2014, as an indicator for the rise in member base for October 2014. As of August 31 2014, Costco had about 76.4 million cardholders, while it had only 71.2 million cardholders in the quarter ending on September 1 2013. Making a conservative assumption that the number of cardholders from August to October increased by a similar amount during both the years, we conclude that October 2014 had 5.2 million more cardholders that October 2013. Also, membership renewal rates in North America and worldwide were 90.6% and 87.3%, respectively, at the end of Q4 fiscal 2014, up from 90% and 86.3% respectively, in the same quarter last year.

The better retail environment in October also helped Costco’s comparable sales growth. Encouraged by a promising job scenario, U.S buyers opened up their wallets during the month, which resulted in 4% year over year growth in U.S. retail sales. The unemployment rate fell to a five year low of 5.8%, which had a positive impact on consumer sentiment. The Thomson Reuters/University of Michigan’s U.S. consumer sentiment index rose to 86.9 during the month, which was its highest value in over seven years. As a result, U.S. buyers were more generous with their spending during this year’s Halloween shopping, which resulted in strong retail growth during the fourth week of the month.

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Retail Week In Review: Wal-Mart, Target & Costco

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Monday, October 13th, 2014 by

Last week, National Retail Federation (NRF) released an optimistic sales growth forecast for the upcoming holiday season. It predicts retail sales during November and December 2014 (excluding gas, autos and restaurant sales) to increase by 4.1%, while they increased by just 3.1% last year. While retailers will be encouraged by NRF’s recent forecast, prevailing uncertainty in consumer spending behavior cannot be ignored. Shoppers are likely to remain extremely price conscious during the season, and hence competition in the industry will be intense.

Apart from NRF’s forecast, there weren’t any significant news for U.S. retailers, except Costco (NASDAQ:COST) releasing its Q4 fiscal 2014 earnings. Wal-Mart (NYSE:WMT) eliminated health care benefits for part-time employees and Target‘s (NYSE:TGT) CEO commented on its strategies to salvage Canadian operations. Here is a quick roundup of news that mattered for these companies.

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Costco Beats Estimates On Strong Online & Membership Growth

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Thursday, October 9th, 2014 by

Warehouse giant Costco (NASDAQ:COST) recently reported Q4 and fiscal full-year 2014 results that came in ahead of the market consensus. (Fiscal years end with August.) The retailer’s revenues for the fourth quarter increased 9% to $35.52 billion, while analysts polled by Thomson Reuters expected the figure to be around $35.47. With strong sales growth and improvement in gross margins, Costco’s earnings per share jumped 13% to $1.58, comprehensively beating the consensus estimate of $1.52.

The retailer’s income growth looks even more pleasing considering that certain items negatively impacted its earnings. Unfavorable currency fluctuations lowered Costco’s Q4 fiscal 2014 EPS by $0.02 and income tax charges related to integration of Canadian operations with the U.S. business resulted in similar negative impact. Moreover, the company did not reduce its accrual for year end bonuses (as it did last year), that had a negative impact of $0.04 on its Q4 EPS. In the absence of these items, Costco’s EPS would have been $1.66, which looks very impressive.

Apart from store expansion, the retailer’s strong revenue growth can be attributed to a healthy rise in new membership signups. Given the strength of its business model, Costco has been able to attract new memebrs, which should continue in the future given that it is expanding steadily in key new markets. Also, Costco’s e-commerce sales increased at a robust pace during the quarter, which not only had a marginal positive impact on its sales growth, but also on gross margins. The company is employing several strategies to ensure that its direct-to-commerce segment maintains a strong growth rate going forward, even as it builds a strong foundation for omni-channel retailing.

Our price estimate for Costco stands at $123, implying a discount of about 5% to the current market price. However, we are in the process of updating our model in light of the recent earnings release.

See our complete analysis for Costco

Membership Growth Sustains a Strong Momentum

Over the last few years, Costco has seen a notable increase in the number of new members. While the retailer added 2.3 million members in fiscal 2009, more than 4 million customers signed up in fiscal 2011. The retailer’s membership base saw a rise of 3 million in fiscal 2012 and another 4.2 million joined Costco in fiscal 2013. Membership growth continued in all the four quarters of fiscal 2014. During the third quarter, new membership signups increased by 1% and renewal rate in the U.S. and Canada reached 90.6% from 90.4% in Q2. In international markets, it rose from 86.8% in Q2 to 87.3% at the end of Q3.

The fourth quarter of fiscal 2014 was particularly productive for Costco’s gross member additions. The retailer saw 2 million new membership signups during the quarter, which reflected an increase of 7% year over year. The surge in new signups was driven by strong response in international store openings in Australia, Korea and Spain. Overall, the company had a total of 76.4 million cardholders at the end of fiscal 2014, 1.8 million more than what it had at end of Q3. While overall renewal rates remained constant during the quarter, Goldstar renewal rates ticked up slightly from 89.6% (Q3) to 89.7%.

Given that membership renewal rates are already on the higher side, the company cannot expect much improvement going forward. However, with continued expansion and several efforts to attract customers, Costco can sustain sturdy growth in its new membership signups. During fiscal 2014, the company opened a total of 30 stores, including 17 in the U.S., three each in Canada and Australia, two each in Japan and Korea, and one each in the U.K., Mexico and Spain. In the current fiscal, Costco plans to open a total of 31 outlets, 13 of which will be in international markets. The retailer’s warehouse model has seen strong adoption in the U.S. and early signups in Australia and Japan have been very strong. With continued expansion in these regions, Costco should have no problems in adding new members.

Costco recently ran an eight day nationwide promotional program “Living Social” to entice buyers to become Costco members. It offered $20 Costco Cash card to new $55 membership signups along with three free items – a Kirkland Signature bath tissue, an apple pie and a rotisserie chicken. These free gifts can be construed as a goodwill gesture from the company, rather than an incentive for the buyers to join Costco. The retailer also started providing a free three month membership for identity theft protection, seeing how the recent data breaches have left customers with minimal confidence in credit payment systems. With the company enhancing its cyber security and encouraging buyers to sign up for it, we believe that customers will feel more secure about their transactions at Costco. This should have some positive impact on new membership signups going forward.

Online Growth Impresses

Costco generated a total of $3 billion in e-commerce revenues in fiscal 2014, which represents less than 3% of the company’s net sales. While the segment isn’t strong enough to have a material impact on Costco’s results, its strong and steady growth should not be ignored. Although the channel itself may not turn into a significant value contributor in the future, it will lay a strong foundation for Costco’s omni-channel platform.

Comparable sales for the retailer’s fourth quarter e-commerce sales increased 19%, driven by key factors including: 1) an industry-wide customer shift towards online shopping; 2) Costco’s website re-platforming; 3) the introduction of new apps; 4) the addition of new categories such as apparel, health, beauty sundries, etc.; and, finally, 5) an improvement in delivery times. Over the past  year, the retailer has been testing Google Shopping Express, a Google (NASDAQ:GOOG) initiative that provides consumers a platform to shop online from local retailers and get products delivered on the same day. Through this, Costco is mainly looking to expand its e-commerce reach, but it is still in test phase in three markets – the San Francisco Bay Area, Los Angeles and New York. In the years to come, the warehouse giant might look to roll this out on a larger scale, one that can have a noticeable impact on its e-commerce revenues.

Apart from contributing marginally to sales growth, Costco’s e-commerce business also helped its gross margins. The company’s chief financial officer, Richard Galanti, said during the earnings call that gross profit margins in e-commerce business are better than they are in the store business. Hence, online segment’s share in Costco’s overall profits is higher that its share in overall revenues (~3%). During the quarter, the retailer’s gross margins ticked up 15 basis points year over year to 10.7%, driven by higher margins in food and sundries, as well as rise in e-commerce profits. This looks quite promising considering that margins have declined steadily for most retailers in the U.S. over the last couple of years.

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Costco Earnings Preview: Improving Conditions In The U.S. And Robust International Growth Will Drive Results

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Tuesday, October 7th, 2014 by

Leading U.S. warehouse club Costco (NASDAQ:COST) is scheduled to report its Q4 fiscal 2014 results on October 8. In a recent press release, the company reported that its comparable sales during the quarter increased by a healthy 7%, excluding the negative impact of declining  gasoline prices  and currency effects. Costco’s comparable sales in the U.S. increased by 6% as the company maintained its strong position in the gradually improving retail market. Internationally, the growth was more promising at 8%, which was driven by a rise in number of members in key international markets.

Driven by the sluggish economic environment, U.S. buyers in numbers have switched to Costco to take advantage of its attractive bargains. This has translated into significant improvement in new membership signups and renewal rates, which have subsequently boosted comparable sales growth in the U.S. In international markets, Costco has found tremendous acceptance due to its cost-saving shopping model. As a result, the company’s international revenue and comparable sales growth, have outpaced its domestic growth for four consecutive years.

Our price estimate for Costco stands at $123, which is just below the current market price.

See our complete analysis for Costco

As the U.S. Market Improves, Costco Performs Better

Costco performed very well in the U.S., even when the retail environment wasn’t too conducive for several retailers including Wal-Mart (NYSE:WMT) and Target (NYSE:TGT). As the market conditions got better, the warehouse giant’s results improved further. In June 2014, the company reported 6% rise in comparable sales, on top of similar growth in the same month last year. During the month, retail sales across the U.S. improved by 3.8% driven by strong sales during the Independence Day weekend, according to Redbook Research. June 2014 was a five-week period on the U.S. retail calender that ended on July 5 and included the Independence Day weekend. U.S. buyers opened up their wallets in June as the unemployment rate fell to 6.1%, the lowest rate since the recession set in.

In July, Although Costco’s comparable sales growth slowed down a little to 5%, due to a fall in foot traffic, it was still much better than what other retailers realized during the month. The unemployment rate went up slightly to 6.2% and buyers continued to buy more online, where Costco’s presence is limited. However, the company sustained its gross member additions, figures of which will be revealed in the upcoming earnings call. Costco picked up its growth momentum in August with 7% rise in U.S. comparable sales, as consumer sentiment improved due to a better job environment. The Thompson Reuters/University of Michigan consumer sentiment index increased to 84.6 in early September (highest since July 2013) as unemployment rate fell to 6.1% in August and fuel costs came down. As a result, consumer affordability improved, supporting an increase in August retail sales of  0.6% month over month.

Overall, U.S. retail sales for the June-August period increased by 4.5% and Costco’s comparable sales growth remained 1.5 percentage points ahead of the industry growth. This clearly reflects the warehouse giant’s supremacy in the U.S. retail market.

International Results Continue to Impress

Over the past four years, while Costco’s revenues in the U.S. have grown at an average annual rate of 5%, its international revenues have increased by almost 15% annually. It appears that consumers in international markets are welcoming the retailer’s business model, which promotes cost saving. In fact, early signups in Asia and Australia have been very strong, which is encouraging Costco to continue its expansion in these regions. Most of Costco’s growth is coming from its biggest international market – Mexico, where the recent economic slowdown has not troubled the retailer. In constant currency terms, Costco’s international comparable sales increased by almost 8% during June 2014, following 7% growth in the prior month. In the subsequent months, the company’s comparable sales increased by 7% and 8% respectively, taking its quarterly comparable sales growth to 8%. Such robust and consistent growth indicates that Costco is gaining momentum in key international markets.

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Why Costco Needs To Watch Out For Amazon & Sam’s Club?

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Monday, October 6th, 2014 by

Costco (NASDAQ:COST), the largest warehouse club in the U.S., has maintained a strong growth momentum over the last couple of years despite the edgy retail environment. The company’s total merchandise sales have grown at an average annual rate of nearly 10% for the past four years, exhibiting both  gradual expansion and sturdy comparable sales growth. Even this year, Costco’s comparable sales have grown at an impressive rate every month, while major retailers such as Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) are struggling for positive growth.

While everything seems to be going right at the moment, there are some factors that can pose a serious threat for the company in the long term. Amazon‘s (NASDAQ:AMZN) rapid growth and growing showrooming are ringing alarm bells for a number of retailers, including Costco. The online giant has expanded its product portfolio aggressively over the last few of years, which has incentivized buyers to stay at home and shop online. Amazon isn’t the only player who can challenge the warehouse giant in the long run. Sam’s Club, which offers a lower membership fee, has a wider reach and can leverage Wal-Mart’s (NYSE:WMT) huge size to get better discounts from its vendors.  It can also turn into a threat for Costco. In this analysis we discuss why Costco needs to take them seriously.

Our price estimate for Costco stands at $123, which is just below the current market price.

See our complete analysis for Costco

Amazon – Showrooming and Rapid Growth

Showrooming refers to the phenomenon wherein shoppers visit physical stores to examine products first hand, only to find and buy them cheaper online. It’s no longer just a media hype, but has become a real concern for a number of retailers. Amazon has emerged as the biggest threat on this front. The company offers and promotes free mobile apps to encourage its customers to compare prices of various products while walking in different stores. According to a survey conducted by Seattle-based startup Placed last year, apart from retailers such as Target (NYSE:TGT), Best Buy (NYSE:BBY) and Bed Bath & Beyond (NASDAQ:BBBY), showrooming can also impact the warehouse giant Costco.

This study included the response of 15,000 customers as well as their movement analysis through the physical world. According to the study, about 45% of Amazon’s prime customers (who pay $79/year for free two-day shipping) will more likely shop at Costco than an average shopper. Moreover, there is a 38%  greater chance for Amazon’s showroomers to visit Costco as compared to other showroomers. This indicates a big overlap between Amazon’s and Costco’s customers, which is not a good news for the latter.

Considering the rapid growth of Amazon’s product categories, showrooming becomes an even greater threat. The company has demonstrated the ability to quickly grow the product portfolio, modify it to remain in line with Costco’s products and deliver merchandise in less than two days. Amazon offers a compelling range of consumer electronics and jewelry items, categories which have been important for Costco’s growth. A few years back, Amazon bought Quidsi, the parent company of Diapers.com, Soap.com and BeautyBar.com, to expand its merchandise selection and start selling in bulk. In addition, it also operates a local grocery-delivery service known as AmazonFresh. Although the online grocery business hasn’t been that successful in the U.S., this service somewhat places Amazon on Costco’s turf. The continued growth of the online retailer might raise more concerns for Costco in the future.

Sam’s Club – Cheaper Membership and Wider Reach

Although Costco is the leading warehouse retailer in the U.S., it faces stiff competition from its closest competitor, Sam’s Club. While Costco has a larger customer base, there are some factors that make Sam’s Club a more attractive choice for customers, thus making it a potential threat for the warehouse giant. Compared to an annual membership fee of $55 at Costco, Sam’s Club charges only $45 from its members. While an executive member at Costco pays $110 per year, Sam’s Club’s plus members pay only $100. The rewards offered by both retailers are quite similar, and amount to 2% of their annual purchases. It appears that Sam’s Club has a clear competitive advantage in terms of membership fee.

Costco operates just over 450 stores in 40 states of the U.S. and Puerto Rico, with high concentration around California. The retailer earns about 24% of its domestic revenues from the region, indicating that it is susceptible to self-cannibalization. On the other hand, Sam’s club is evenly spread across the U.S. with 630 stores in 47 states and Puerto Rico, clearly implying that it has a wider geographical reach and fewer risks of auto-cannibalism. Sam’s Club also provides excellent services for delivery, installation and technical support. When it comes to groceries, which is the largest product category sold by both warehouse retailers, Sam’s Club was found to be cheaper than Costco. Overall we believe that Sam’s Club has a small edge over Costco due to its lower membership costs, good customer service and generous return policies. It may not be a concern for Costco right now, but Sam’s Club can turn into a formidable threat in the future.

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Retail Week In Review: Wal-Mart, Target And Costco

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Monday, September 22nd, 2014 by

The past week in the U.S. retail industry was mainly about major retailers, Wal-Mart (NYSE:WMT) and Target (NYSE:TGT), unveiling their plans for holiday hiring. While the retail giant decided to increase its hiring as compared to 2013 for the busiest season of the year, cheap chic retailer decided against it. In other news, warehouse giant, Costco (NASDAQ:COST), ended its partnership with American Express in Canada, as both parties could not settle on some terms of a new agreement. Costco will now switch from American Express to Capital One and MasterCard, for issuing its credit cards in Canada. Here’s a quick roundup of the news that mattered for the retailers that we cover.

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Week In Review: Wal-Mart, Costco And Target

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Friday, September 5th, 2014 by

Nothing significant happened in the U.S. retail market this week as Wal-Mart (NYSE:WMT) persisted with its lack of interest in Family Dollar, even as Dollar General and Dollar Tree entered a bidding war for the same. Cheap Chic retailer, Target (NYSE:TGT), had its investment rating downgraded by a couple of research groups as data breach repercussions, botched up Canadian operations and edgy U.S. retail environment continued to trouble it. However,  Costco (NASDAQ:COST) brightened retail news as it reported its best monthly comparable sales growth since December 2012. Here’s a quick roundup of the news that mattered for the retailers that we cover.

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Costco’s July Sales Grow Strong but Miss Estimates Due to Fewer Store Visits and Currency Fluctuations

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Friday, August 8th, 2014 by

Costco (NASDAQ:COST) recently reported its July sales results and missed analysts’ estimates for the first time in the last five months. The retailer’s comparable sales increased by 5% during the month, while the market expected the metric to increase by 6%. However, excluding the impact of lower gasoline prices and foreign currency fluctuations, Costco’s comparable sales growth was in line with the consensus estimate. Overall, the company’s net sales grew by 9% to $8.55 billion and its comparable sales increased by 5% in the U.S. and 7% abroad.

Amid an uncertain economic environment in the U.S., the warehouse shopping model has become very popular among buyers looking for cost-saving deals. Being the strongest warehouse retailer in the U.S., Costco has been customers’ first choice, which is evident from its growing member base. For several quarters now, the company has registered a rise in its membership renewal rates and new membership signups.

While Costco’s July growth was driven by the continued adoption of warehouse shopping model, a decline in store traffic across the industry had a marginally negative impact. During July, some buyers preferred Internet shopping over store shopping, which had a notable negative impact on the industry-wide store traffic. Yet, the surge in online orders resulted in better-than-expected retail sales growth across the market. Sales of eight retailers tracked by Thomson Reuters increased by 4.4%, which was slightly ahead of the expected 4.2% growth. Since Costco’s online channel isn’t too big, its store traffic decline would have easily overpowered a strong surge in online revenues.

Our price estimate for Costco stands at $123, implying a premium of less than 5% to the market price.

See our complete analysis for Costco

Rise Is Membership Base Is Driving Comparable Sales

Historically, Costco has generated the bulk of its comparable sales growth from an increase in number of members, which appears to be the case in July as well. While the company does not provide details related to its member base on monthly basis, we will consider the increase in number of members from Q3 fiscal 2013 (the quarter that ended before July 2013) to Q3 fiscal 2014, as an indicator for the rise in member base for July 2014. As of May 11 2014, Costco had about 74.6 million cardholders, while it had only 69.9 million cardholders in the quarter ending on May 12 2013. Making a conservative assumption that the number of cardholders from May to July increased by a similar amount during both the years, we conclude that July 2014 had 4.7 million more cardholders that July 2013. Also, membership renewal rates in North America and worldwide were 90.6% and 87.3%, respectively, at the end of Q3 fiscal 2014, up from 89.9% and 86.4% respectively, in the same quarter last year.

Slump in Store Visits Might have had a Marginally Negative Impact

Due to increased proliferation of smartphones and tablets, and the convenience of web shopping, U.S. buyers have been making more purchases online. Subsequently, they are visiting fewer stores, which is troubling a number of retailers who do not have a sizable online presence. As per the data compiled by ShopperTrak, a firm that tracks store traffic in over 40,000 outlets across the U.S., store visits have fallen consistently by close to 5% year-over-year in all the months of the past two years. This trend continued in July as 5% fewer shoppers went out for shopping, which impacted the sales of retailers such as Costco and Wal-Mart (NYSE:WMT) who rely on store sales for a bulk of their revenues. It must be noted that even though Costco’s online sales might have increased considerably, its web channel isn’t big enough to have a noticeable impact on sales growth. Also, July is traditionally a clearance month in which retailers discount their products to make room for back-to-school inventory. Costco might have also done the same, which would have resulted in a marginal slowdown in its sales growth.

Although Costco could not meet market expectations in July, we believe that the consensus estimate was a little optimistic. Moreover, foreign currency fluctuations had a negative impact of a whole percentage point on the company’s comparable sales growth. Considering this, we conclude that Costco hasn’t lost any growth momentum in July despite the unfavorable environment.

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Costco Sustains Its Growth Momentum In June

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Friday, July 11th, 2014 by

Warehouse giant Costco (NASDAQ:COST) recently reported its June sales results that were slightly better than analysts’ expectations. The retailer’s net sales grew by 10% to $10.89 billion and its comparable sales increased by 6% with similar growth in the U.S and 7% growth in international markets. Excluding the impact of foreign currency fluctuations, Costco registered 8% growth in its international comparable sales. June was the fourth consecutive month when Costco was able to beat street estimates driven by its growing member base.

Amid an uncertain economic environment in the U.S., warehouse shopping model has become very popular among buyers looking for cost-saving deals. Being the strongest warehouse retailer in the U.S., Costco has been customers’ first choice, which is evident from its growing member base. For several quarters now, the company has registered a rise in its membership renewal rates and new membership signups. Also in international markets, Costco has found tremendous acceptance due to its unique shopping model that promotes cost savings.

While Costco’s supremacy in the U.S. propelled its growth in June, strong retail trends during the month also had a positive impact. According to Redbook Research’s latest reports, retail sales in June increased by 3.8% driven by strong sales during the Independence Day weekend. June 2014 was a five-week period on the U.S. retail calender that ended on July 5. Strong sales of seasonal products and attractive promotions during the last week of June boosted store traffic, resulting in 6% rise in sales during the week as compared to the same period last year. Costco also observed the Independence Day in its 34 days June retail period.

Our price estimate for Costco stands at $123, implying a premium of less than 5% to the market price.

See our complete analysis for Costco

Rise In Number Of Members Is Driving Growth For Costco.

Costco’s June results look impressive considering that its comparable store sales growth in the U.S. (6%) and international markets (8%) was on top of similar growth figures seen in the same month last year. While the company does not provide details related to its member base on monthly basis, we believe that a rise in number of members was the primary growth driver for its comparable sales growth in June. For the purpose of this analysis, we will consider the increase in number of members from Q3 fiscal 2013 (the quarter that ended before June 2013) to Q3 fiscal 2014, as an indicator for the rise in member base for June 2014. As of May 11 2014, Costco had about 74.6 million cardholders, while it had only 69.9 million cardholders in the quarter ending on May 12 2013. Making a conservative assumption that the number of cardholders from May to June increased by a similar amount during both the years, we conclude that June 2014 had 4.7 million more cardholders that June 2013. Also, membership renewal rates in North America and worldwide were 90.6% and 87.3%, respectively, at the end of Q3 fiscal 2014, up from 89.9% and 86.4% respectively, in the same quarter last year.

Growing popularity of warehouse shopping model and Costco’s attractive bargains have played a crucial role in driving its member base. Some consumer reports suggest that buyers can save up to 55% while shopping at warehouse clubs. Due to these attractive bargains, warehouse club industry sales have grown at a significantly higher rate than general merchandise store sales in the U.S. over the past decade. Being the largest player in the industry, Costco has been at the forefront of this growth. As a warehouse retailer, Costco keeps its product markups low at 15%, while several supermarket chains markup their goods by 25%. The retailer changes the brands and product categories in its stores regularly to give its customers a “treasure hunt” experience. To add a greater appeal, Costco adds high-end products such as Coach (NYSE:COH) purses and Dom Perignon champagne to its shelves from time to time. The company offers a number of private label brands that are cheaper than national brands, but comparable in quality. These brands are very popular among Costco’s customers and have played an important role in its sales growth.

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Costco Is Not Eying China For Now

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Tuesday, July 1st, 2014 by

Warehouse giant Costco (NASDAQ:COST), which has operations in nine countries, including the U.S. and Mexico, still does not have any concrete plans for China. This is somewhat surprising considering that China is the second largest economy in the world with a huge retail market that stands well over $2 trillion and is growing at a robust pace. The region has been among the most preferred international expansion options for several retailers, apparel players and consumer electronic chains, but Costco has shown no significant interest in the market. The reason behind the warehouse retailer’s lack of interest in China is that foreign retailers have struggled to adapt themselves to the Chinese market. Retail giant Wal-Mart (NYSE:WMT), home improvement retailer Home Depot (NYSE:HD) and electronics chain Best Buy (NYSE:BBY) have had a hard time selling their products to discerning Chinese shoppers.

Costco’s CEO believes that the company does not need to focus on China at the moment since its operations in other Asian countries are going very well. At the moment, there appears no lack of growth for the company in domestic as well as international markets, which is why it has set China aside for later. It seems that Costco does not want to enter a market that hasn’t done much good for U.S. retailers so far.

Last year, there was a report in The Southern Metropolis Daily (a Chinese Newspaper based in Guangzhou) that Costco is looking for a local partner to launch e-commerce operations in China. While the report indicated that the company is finally looking to set its foot in China, launching only e-commerce websites might not be the best idea. Costco’s core value proposition isn’t limited to its low priced products, but also includes the shopping experience. While the company can offer cheaper products over the Internet, it cannot replicate the enticing store environment where shoppers have access to several ancillary services. With absence of those services, Costco may find it hard to make a strong first impression in the unforgiving Chinese retail market.

Our price estimate for Costco stands at $123, implying a premium of less than 5% to the market price.

See our complete analysis for Costco

The Chinese Retail Market Hasn’t Been Fruitful For U.S. Retailers

Chinese consumers are very cautious and their buying decisions aren’t always price driven. They are more inclined towards tailor-made products and a shopping environment that reflects local touch. Along with prices, Chinese buyers are concerned about authenticity and quality of products. Due to these factors, U.S. retailers entering the region haven’t been able to adapt themselves to the local environment, which has resulted in sluggish growth. Moreover, the Chinese retail market has a number of established local players who have outperformed their foreign counterparts with a better understanding of consumer behavior.

Despite offering lowest prices in the market, retail giant Wal-Mart hasn’t been able to attract customers. Chinese shoppers are accustomed to buying their groceries at local outdoor markets and Wal-Mart has been unable to customize its stores accordingly. On the other hand, its local counterpart, Sun-Art, has successfully recreated that environment with fishing tanks, in-store noodle stands, fresh seafood displayed on table tops, etc. One of the largest electronics retail chain in the U.S., Best Buy, has struggled in China due to its premium prices and tough competition from local electronics chains such as Suning and Gome. Best Buy opened stores in China that were similar in infrastructure to its U.S. stores, which provided a better shopping environment than Suning and Gome. However, this did not work in Best Buy’s favor since Chinese buyers are used to shopping for electronics in warehouse-style stores, which Suning and Gome have exploited to good effect. Best Buy’s store environment turned out alien to Chinese buyers and its products were perceived as expensive.

The Chinese retail market has been unrelenting to even slightly different retailing environments and Costco is a different retail concept altogether. While the warehouse retailer can offer good quality products at low prices, customer response to its store format cannot be predicted, which increases the risks involved in investing in China.

No Concrete Plans For China

In an interview last year, Costco CEO Craig Jelinek stated that the company doesn’t feel the need to enter China yet as its other Asian business is doing very well. He believes that there are a lot of opportunities available in countries such as Japan, Taiwan and Korea, and expanding in China might turn out to be a risky move. Jelinek stated that Costco does not want to stretch its business beyond the management’s control and China will be a good expansion option even after 10-15 years.

It appears that the company doesn’t feel the need to expand in China as it has no growth problems in the U.S. or its current international locations. We believe that once Costco runs out of growth room in the U.S., it will consider China as the next destination for store expansion. The company’s warehouse concept has gained significant traction in Taiwan, where consumer behavior is somewhat similar to China. Even with a small number of stores, Costco’s brand popularity in Taiwan has grown tremendously. We believe that a pleasing customer response in Taiwan is an indication that Costco can be successful in China as well, if the company decides to open its stores there.

Speculations Of E-Commerce Expansion

About a year back, there was a report in a Chinese newspaper that Costco is planning to expand its e-commerce operations in the country and is looking for a local partner. While the company hasn’t confirmed the news yet, we believe that Costco will look for e-commerce expansion in the region before opening its physical outlets. The idea behind this strategy is not to invest too much in a market that hasn’t been conducive for U.S. retailers and to explore China’s huge e-commerce space ($194 billion in 2012) before expanding its retail footprint.

However, an online store will lack Costco’s traditional store characteristics that have played a crucial role in its success. At Costco, shopping is not just about prices but the shopping experience as well, which includes a “treasure hunt” experience where shoppers walking around the isles always find something new. Also, they have access to several ancillary services such as food court, photo-center, pharmacy, gas station, etc.

With only online launch in China, Costco won’t we able to provide these social experiences. Even if the company alters between its brands in order to recreate the “treasure hunt” experience over the Internet, its ancillary services will be absent. A deep analysis of Costco’s sales in the U.S. suggests that while average spending per customer on merchandise has grown slowly over the past four-five years, their spending on ancillary services has increased at a hefty pace. Hence, by not providing these services in China from the outset, Costco’s first impression on buyers will not be too strong. This can make it difficult for the company to elevate its brand image in the future.

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