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Investment Overview for Costco (NASDAQ:COST)
Below are key drivers of Costco's value that present opportunities for upside or downside to the current Trefis price estimate for Costco:
- Revenue per Square Foot for Costco US : Revenue per Square Foot for Costco US has increased from about $809 in 2006 to $867 in 2011. It is an important metric to measure retail sale success and is a factor that drives operating margins. Trefis expects it to increase and reach $898 by the end of the forecast period. Increasing penetration of executive membership is expected to drive Revenue per Square Foot for Costco US. If Revenue per Square Foot for Costco US increases to $1000, there could be an approximately 4% upside to our estimate for Costco price. On the other hand, if it decreases to $750, it represents about a 5% downside to the Trefis estimate for Costco's stock.
- Number of Costco US Warehouse Clubs: Costco has been steadily expanding in the US by opening more stores. The figure has increased from about 369 at the end of 2006 to 429 at the end of 2011. Trefis expects these warehouse clubs to continue to rise at a moderate rate in the coming years. In case, the number of Costco US Warehouse Clubs reaches 550 by the end of the forecast year, there could be a 4% upside to the Trefis estimate. On the other hand, there could be a downside of approximately 4% if the US Warehouse Clubs count reaches 440 by the end of the forecast period.
For additional details, select a driver above or select a division from the interactive Trefis split for Costco at the top of the page.
Costco is the second largest retailer in the U.S. and the largest in the warehouse club category with revenues of over $90 billion in 2011. Costco operates on the business model of charging membership fees from its customers in exchange for heavy discounts on selected brands of a wide variety of merchandise. At the end of 2011, the company operated about 592 warehouses globally; including 429 in the U.S., 82 in Canada, 32 in Mexico, 22 in U.K., 9
in Japan, 8 in Taiwan, 7 in Korea, and 3 in Australia. It has approximately 64,000 members including 25,000 gold members. Besides selling merchandise, Costco provides in-store services like fuel, hot-dog stands and optical centers to attract customers to shop more frequently.
Costco competes with Sam's Club and BJ's in the warehouse club business. Its competitors have a very similar business model. However, BJ's focuses primarily on retail shoppers while Costco and Sam's Club concentrate on small business customers. Thus, Costco primarily competes with Sam's club nationwide while BJ's presence is limited to fewer areas of the US. Warehouse clubs tend to attract business customers with additional rewards and services. For example, Costco offers 2% annual reward for its executive members along with additional benefits of services like home insurance, check printing, business telephone service etc.
Costco has been successful in delivering impressive comparable sales growth. For instance, its comparable sales increased 10% in 2011 as compared to the 2010 levels. Inn 2010, the increase was 7% over the 2009 levels. Costco's US operations contribute approximately 72% to its sales followed by a 16% contribution by Canada and 12% by other international operations as of the 12 months ended February 12, 2012.
Higher number of warehouses in the US than international
The Core Merchandise US segment is the most valuable to the company. Costco has built a strong relationship with its customers and is clearly positioned to thrive in a weak economy. Costco operated about 429 warehouse clubs (close to 73% of total warehouses) in the US versus 163 warehouse clubs internationally as of the end of 2011. These warehouses contributed to about 80% of Costco's total sales (including membership fee).
Increasing penetration of executive members
Executive members tend to have higher renewal rates than other members. For example, membership renewal rates are about 92% for executive members, 4% to 5% higher than the overall membership renewal rates. Executive membership penetration is on an upward trend and has increased from about 23% in mid 2007 to about 38% in 2011.
International markets present a huge opportunity
Costco has expanded in Canada and in the UK. Nonetheless Costco still has the big opportunity to expand in the Asian and Australian markets, where it has a limited presence. Costco has the capability to operate about 100 stores in Taiwan, Korea and Japan combined and about 20 stores in Australia. This clearly indicates the expansion opportunity in these selected countries. China and India could be potentially huge markets for future expansion. Other big retailers like Wal-Mart have expressed interest in these markets and are exploring various opportunities to grab the share of the growing retail market in these two economies.
Unique business proposition likely to be received positively in newer markets
Warehouse clubs like Costco present unique opportunities for regular and bulk buyers to save money by buying merchandise discounted at higher rates compared to other retailers. This business model has enabled Costco to thrive despite the weakening economy and is likely to boost sales in developing markets where consumers and businesses are even more cost conscious.
Focus on internet and smartphone expansion
Costco.com has been successful in attracting traffic to its site. Both sales and profits have witnessed impressive increases over the past year. Costco has plans to transition to a new platform this summer which would provide greater visibility to its online platform. It also has plans to launch its first app on smartphones to lure tech savvy customers.
Keen to foray into other lucrative areas
Costco is strategically trying to enter other market segments by partnering with strong existing players in the industry. In April 2012, Costco launched a mortgage program in partnership with First Choice Bank and 10 other lenders. It intends to leverage its customer base and wider presence to market this program. Costcofinance.com, Costco's mortgage lending site, gathers rates from different lenders and provides a summary of competitive quotes to its customers. In return, it gets paid for marketing this service to its customers.
It has also partnered with Aetna, one of the world's largest managed health care services company, to offer health insurance services. The Costco Personal Health Insurance program offers five Aetna health plans with major medical benefits and dental coverage. This partnership would likely benefit from several synergies associated with Costco's affluent customer profile and Aetna's expertise in the health insurance industry.
Threat of self cannibalization exists
Although the company still has scope for expansion in the US, we do not negate the possibility of self-cannibalization. Going forward, we expect the US market for the company to saturate in terms of geographic coverage, and expect Costco to focus on international expansion.
Focus on increasing penetration of executive membership
Executive members, who account for about 60% of the sales and who also pay higher membership fee, are the most valuable to Costco. Executive members tend to have higher renewal rates than other members. Executive membership penetration is on an upward trend and has increased from about 23% in mid 2007 to about 38% in 2011.
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. 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.
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, Kohl's and Amazon.com in the general merchandise retail segment.
With the onset of online retailers like Amazon and eBay, the competition has led to competitive pricing which in turn, has led to a fall in prices and gross margins consequently.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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