What Factors Support Our Bullish Outlook On Costco?
Quick Take
- Costco’s stock price has risen by about 20% over the last year, and our estimates imply that there is still some upside value to the shares.
- Increasing membership signups and improving membership renewal rates due to Costco’s attractive bargains should assist growth.
- Growing penetration of executive members and the rising proportion of private label brands are some other major driving factors.
- Costco’s e-commerce strategy will help it leverage growth in the online retail market.
Costco (NASDAQ:COST) is the largest and the most successful warehouse club in the U.S. The company’s stock price has increased by around 20% over the last year due to its strong financial performance.
Our price estimate for Costco stands at $113, implying a premium of about 10% to the market price. We believe that the premium is justified driven by Costco’s increasing customer base and attractive bargains. The retailer’s focus on executive members and private label brands will help its revenue growth. In addition to this, Costco is strengthening its e-commerce channel to better serve customers and leverage the growing online retail market.
See our complete analysis for Costco
Attractive Bargains Fueling Membership Growth
As a warehouse club, Costco provides merchandise at lower prices compared to its competitors. The retailer does so by keeping product markups low at around 15% while the same figure for most supermarkets and department stores is over 25%. [1] [2] Moreover, with concrete floors, simple shelves and display boxes, Costco keeps costs to a minimum. [3] The retailer possesses strong negotiating power over its vendors as it buys large quantities of fewer SKUs. Also, it regularly changes the brands it offers by buying the brands that have larger inventories to get more discounts. [4] Hence, customers always find something new at Costco. These strategies allow the retailer to offer merchandise at compelling prices, attracting buyers to become Costco members. To add more appeal, the retailer offers high-end products such as Coach (NYSE:COH) purses and Dom Perignon champagne from time-to-time. [1] Besides this, Costco also provides gasoline at discounted prices, thus creating an incentive for value-conscious customers.
Over the last few years, Costco has witnessed a noticeable increase in the number of new members. While the retailer added 2.3 million members in 2009, more than 4 million customers signed up in 2011. [5] The company stated that over 1.6 million new members joined Costco during the first two quarters of fiscal 2013. [6] [7] Moreover, the membership renewal rates have improved in the recent times as customers are returning to Costco, troubled by the gasoline price rise and payroll tax increase. While the membership renewal rate for North America remained flat at 89.7% during Q1 fiscal 2013, it improved slightly to 89.8% in the second quarter. [7] Similarly, the figure for international markets increased to 86.5% in Q2 after remaining stable at 86.4% for two consecutive quarters. The improving renewal rate, despite a 10% rise in membership fee that the retailer implemented in November 2011, is an encouraging sign for Costco.
Increasing Penetration Of Executive Members And Private Label Brands
Executive members pay $110 as membership fee (as opposed to $55 paid by the other members) to get 2% (maximum of $750) annual rewards on their purchases. [5] They represent one-third of Costco’s overall customers and two-third of its revenues. The proportion of these members in Costco’s overall membership base has been rising historically, increasing from 33% in fiscal 2009 to 38% in fiscal 2012. Even in Q2 fiscal 2013, while the total number of members increased by 1%, executive members grew by 1.4%. [7] To drive executive member signups, Costco recently increased the rewards cap from $500 to $750. With the increasing proportion of executive members, the retailer will be able to generate higher membership fee and revenues.
A unique 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. [5] The retailer has been increasing the share of these brands within its overall product range by 0.5%-0.75% annually. [6] With the private label brands accounting for 20% of Costco’s merchandise at the end of Q2 fiscal 2013, the retailer’s plans of increasing this figure to 30%+ range appear to be on track. [7]
Growing Online Retail Sales
The online retail market in the U.S. has grown rapidly since 2004, and the growth is likely to continue in the future. Forrester forecasts that online sales in the U.S. will grow 13% to $262 billion in 2013 and reach $370 billion by 2017. [8] We expect the industry trend to drive Costco’s online sales, which will be further complemented by its e-commerce strategy. Costco offers distinct products in its stores and e-commerce site to keep its customers interested. [7] The company stated that about 80%-90% of its products offered online do not overlap with the store inventory. [7] This allows the retailer to operate two distinct channels without having to worry about self-cannibalization.
Understand How a Company’s Products Impact its Stock Price at Trefis
Notes:- Costco’s Unorthodox Strategy To survive The Big Box Apocalypse, Business Insider, Mar 7 2013 [↩] [↩]
- How Costco Became The Anti-Wal-Mart, The New York Times, July 17 2005 [↩]
- 8 Tips For Business Success From Costco’s Jim Sinegal, youngentrepreneur, Aug 8 2012 [↩]
- Inside Costco: Secret’s Of America’s Favorite Stores, abc news, March 29 2010 [↩]
- Costco’s SEC filings [↩] [↩] [↩]
- Costco’s Q1 fiscal 2013 earnings transcript, Dec 12 2012 [↩] [↩]
- Costco’s Q2 fiscal 2013 earnings transcript, Mar 12 2013 [↩] [↩] [↩] [↩] [↩] [↩]
- U.S. Online Retail Sales To Reach $370B by 2017, Forbes, Mar 14 2013 [↩]