Costco (NASDAQ:COST), the largest warehouse club in the U.S., charges its shoppers an annual membership fee and gives them the opportunity to buy products at heavy discounts. Over the past four years, the company has seen a substantial rise in its membership base, along with healthy comparable store sales growth. During the period of fiscal 2010-fiscal 2013, Costco’s comparable stores grew at an average annual rate of almost 8%. During the same time, around 250 million members joined the retailer.
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However, spending per Costco member on merchandise purchases (U.S. and international, excluding ancillary services) has grown at a slower rate (<3%) than its comparable store sales. This means that more than half of the retailer’s same store sales growth is coming from its increasing customer base. Since average spending by a member is equally important for Costco, we will look at some factors that could add to the growth of this metric.
The retailer is constantly increasing the proportion of its private label brands that provide more cost saving opportunities in bulk purchases. The proportion of executive members (who tend to buy more) in Costco’s overall membership base is on a rise. Moreover, with the retailer’s increased focus on online business, customers will have access to two alternate channels with most of their products different. This should assist the growth of average spending per customer.
Our price estimate for Costco stands at $125, implying a premium of about 5% to the market price.
Increasing Proportion Of Private Label Brands
The key selling point of Costco is its private label brands such as Kirkland Signature. According to the company, these brands comprise premium products that are comparable in quality to national brands and are often cheaper. They also allow the company to earn higher margins. Kirkland Signature is one of the most accepted brands among Costco’s customers and it explains why the retailer has been looking to expand its private brands.
Costco has been increasing the share of these brands within its overall product range by 0.5%-0.75% annually. Kirkland Signature accounted for about 23% of Costco’s merchandise at the end of Q1 fiscal 2014, and the retailer plans to increase this figure to 30%+ range. As the proportion of private label brands increases in the future, it is is likely to have a positive impact on average spending per customer.
Increasing Penetration Of Executive Members
Executive members play an important role in driving Costco’s sales as they represent one-third of Costco’s overall customers and two-third of its revenues. These members pay $110 as membership fee (as opposed to $55 paid by other members) to get 2% (maximum of $750) annual rewards on their purchases. Interestingly, the proportion of executive members in the overall membership base has been rising historically. Back in 2009, they accounted for 33% of Costco’s total members and the figure increased to 38% in fiscal 2013. Even in Q2 fiscal 2013, while the total number of members increased by 1%, executive members grew by 1.4%. In Q4, more than 250,000 customers joined the warehouse retailer as executive members. Since these members get reward points on their purchases, they tend to spend more. Hence, increasing penetration of executive members should help the company generate higher sales per customer along with higher membership income.
Growth In Online Sales
During the first quarter of fiscal 2014, Costco’s online sales increased by 24%, following 20% and 15% growth during the last two quarters of fiscal 2013, respectively. Since the retailer’s online channel accounts for just 2.5% of its net sales, we believe that it can sustain this growth momentum in the future backed by several strategies, such as website re-platforming,the launch of new mobile apps, strong inventory management, and increased product categories. Moreover, online retail sales in the U.S. are expected to grow at a compound annual growth rate of around 10% through to 2017.  This should complement Costco’s growth as well. The retailer is even moving its e-commerce operations to foreign markets and now has presence in four countries – the U.S., Canada, the U.K. and Mexico.
An interesting fact about Costco’s online business is that about 80%-90% of products offered on its website are different from its store inventory. This prevents self-cannibalization between these two channels.  Hence, increased revenues from online business is likely to add up to sales per Costco member.Notes:
- US Online Retail Sales To Reach $370 billion By 2017, Forrester, Mar 12 2013 [↩]
- Costco’s Q1 fiscal 2014 earnings transcript, Dec 11 2013 [↩]