Why Costco Seems A Little Overpriced?
The largest warehouse retailer in the U.S., Costco (NASDAQ:COST) has not had any growth problems over the past several years. In fact, it has reported impressive growth quarter after quarter, driven by its rising member base and steady expansion. From 2008 to 2013, the retailer’s total cardholders increased from 54.2 million to 72.8 million, and its store count increased from 512 to 634. Simultaneously, revenues increased by an average of almost 8% annually. With consistent strong financial performance, Costco’s stock increased by more than 100% over the same period.
However, the retailer’s stock has been up just 18% in the last one year, despite sturdy growth in comparable sales amid a weak retail environment. It appears that the market is not reacting too positively to Costco’s steady growth anymore, due to the anticipation that it will continue in the future without any hurdles. Still, we believe that the company might be a little overpriced. Our price estimate for Costco stands at $130, which is more than 5% below the current market price.
Costco faces stiff competition from Amazon (NASDAQ:AMZN), which can pose a serious threat for the warehouse giant’s future growth. Also, the retailer’s counterpart Sam’s Club has several attributes that give it a competitive advantage over Costco. While the warehouse retailer does not seem to have any issues with competition or customer loyalty at present, imminent threat from Amazon and Wal-Mart’s (NYSE:WMT) warehouse model Sam’s Club cannot be overlooked.
See our complete analysis for Costco
Threat From Amazon
The phenomenon of showrooming, which became prominent with the emergence of Amazon, is the biggest concern for Costco. Showrooming refers to the situation wherein shoppers visit physical stores to examine products first hand, only to find and buy them cheaper online. Amazon actually promotes showrooming among its customers by providing price comparison apps, ensuring them that they will get the best price only at Amazon. A Seattle based startup Placed conducted a survey a couple of years back, which suggested that 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.
According to the study, about 45% of Amazon’s prime customers (who pay $79/year for free two-day shipping) are more likely to 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. [1] The survey meant that if Costco is more expensive than Amazon on certain product categories, buyers who shop at both places will easily know.
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. It also operates a local grocery-delivery service known as AmazonFresh, which gives it a complete product range to compete with Costco. Couple that with the convenience of online shopping, and Amazon becomes a formidable threat for Costco, given that the warehouse retailer’s own online channel is not too strong.
Threat From Sam’s Club
Costco is the largest warehouse retailer in the U.S., but Sam’s Club is not far behind. While Costco reported revenues of $62.2 billion in 2013, revenues for Sam’s Club were at $57.2 billion. Costco has a large member base and hence, it generates higher revenues than Sam’s Club despite a smaller presence. However, there are some aspects 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. Therefore, Sam’s Club seems to have a clear competitive advantage in terms of membership fee.
Also, 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 over 630 stores in 47 states and Puerto Rico, clearly implying that it has a wider geographical reach and fewer risks of self-cannibalization. Sam’s Club also provides excellent services for delivery, installation and technical support. In case of groceries, which is the largest product category sold by both warehouse retailers, Sam’s Club is reportedly cheaper than Costco. Although Sam’s Club may not be a big concern for Costco right now, since Wal-Mart is mainly focusing on its small store expansion, it can present a greater challenge going forward.
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- Survey: Showrooming a threat to Costco, too, The Seattle Times, Feb 27 2013 [↩]