How Costco Is Focusing On Its Organic Food Supply?

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As the demand for organic foods in its stores increases, Costco (NYSE:COST)  is looking at innovative ways to ensure a high quality supply. Reports suggest that the company is working with farmers to help them buy land and equipment to grow organic food products.  While the effort is still at an initial stages and the company is working with just one partner in San Diego, Costco is looking to expand this initiative to ensure greater supply of organic products. Organic food sales have generated double digit growth annually in the U.S. for the past few years and the Organic Trade Association predicts that sales will increase by 12 to 15 percent annually for the next three years.  While high demand without sufficient supply can lead to increase in prices of these products, Costco’s efforts should enable the company to sell organic food products at competitive prices in its warehouses by focusing on increases in supply, without impacting its margins.

Better Control On Supply Chain Can Ensure Steady Margins

As the demand for organic food products grows, prices of these products are witnessing increases, given their limited supply. In order to sell these products at competitive prices to consumers, companies might have to take a hit on their margins to absorb the increasing prices and not pass them on to the final consumers. Costco’s strategy to invest in the supply chain and actively ensure that the supply of these products is not impacted can enable the company to maintain its margins. We estimate Costco’s gross margin to remain steady around 10.5% during our forecast period.

According to a market research report by MarketsandMarkets, the organic food and beverages market is likely to reach $104.5 billion by 2015, up from $ 57.2 billion in 2010. As an increasing number of consumers shift towards healthier food alternatives, demand for organic products will increase significantly. In 2010, the organic food market contributed around 4% to the total U.S. food market in the U.S. However, this sector is expected to grow at a CAGR (compounded annual growth rate) of 14% till 2018.

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Farmers are finding it difficult to keep pace with growing demand of organic products primarily due to the high costs involved with organic farming. If large stores such as Costco fund these costs, it should encourage farmers to increase their organic output. We believe Costco’s strategy to invest in increasing the supply of organic food items will benefit the company significantly, as it taps into the growing demand of these products. The company will be able to offer these products to its consumers at competitive prices, thus generating more revenues, without compromising on margins. This is because greater control of the supply chain will lead to lower costs of these products for Costco. Overall, we believe this initiative should improve Costco’s profitability in the long term.

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