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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 U.S. : Revenue per Square Foot for Costco US has increased from about $818 in 2008 to $942 in 2013. 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 $1,103 by the end of the forecast period. Increasing new membership signups and higher penetration of executive membership is expected to drive Revenue per Square Foot for Costco US. If Revenue per Square Foot for Costco U.S. increases to $1200 driven by growing membership, there could be about 5% upside to our price estimate. On the other hand, if the growth is limited to $1,000, there could be about 5% downside to our price estimate for Costco.
- Number of Costco U.S. Warehouse Clubs: Costco has been steadily expanding in the US by opening more stores. The figure has increased from about 398 at the end of 2008 to 451 at the end of 2013. Trefis expects the store count to continue to rise and reach 524 in the long term. In case, the number of Costco U.S. Warehouse Clubs reaches 580 by the end of the forecast period, there could be 5% upside to the Trefis estimate. On the other hand, there could be a downside of approximately 5% if the U.S. Warehouse Clubs count stabilizes at the current level.
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 $100 billion in 2013. 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 2013, the company operated about 663 warehouses globally; including 468 in the U.S., 88 in Canada, 33 in Mexico, 26 in U.K., 20 in Japan, 11 in Taiwan, 10 in Korea, 6 in Australia and 1 in Spain. It has approximately 76,400 members including 31,600 gold star 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.
Historically, Costco has been successful in delivering impressive comparable sales growth. For instance, its comparable sales increased 6% in 2013 as compared to the 2012 levels. The figure increased by 12% in the prior year and 14% in 2011.
Costco's U.S operations contribute approximately 72% to its sales followed by a 16% contribution by Canada and 12% by other international operations.
Higher number of warehouses in the U.S. 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 451 warehouse clubs in the U.S. versus 183 warehouse clubs internationally as of the end of 2013. These warehouses contributed more than 70% of Costco's total merchandise sales.
Increasing penetration of executive members
Executive members pay $110 as membership fee (as opposed $55 paid by the other members) to get 2% (maximum of $750) annual rewards on their purchases. They represent one-third of Costco’s overall customers and two-third of its revenues. Executive membership penetration is on an upward trend and has increased from about 23% in mid 2007 to about 38% in 2013.
International markets present a huge opportunity
Costco has expanded in Canada and in the U.K. It 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. It currently has 41 stores in Taiwan, Korea and Japan combined and 6 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 e-commerce
Costco has seen tremendous growth in its e-commerce revenues in the recent past. Like other retail chains in the U.S. market, Costco also relies on its store sales for a bulk of its revenues. The retailer earns just 3% of its overall revenues through e-commerce sales. However, this share is likely to go up in the future as the company is deploying several initiatives to develop its web and omni-channel platform.
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 2013.
Increasing penetration of private label merchandise
The key selling point of Costco is its private label brands such as Kirkland Signature. According to the company, these brands are comparable in quality to national brands and are often cheaper. The retailer has been increasing the share of these brands within its overall product range by 0.5%-0.75% annually. Private label brands accounted for about 20% of Costco’s merchandise at the end of Q2 fiscal 2013, and the retailer plans to increase this figure to 30%+ range.
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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