VALUATION HIGHLIGHTS

1. Core Merchandise US constitutes 46% of the Trefis price estimate for Costco's stock.
2. Core Merchandise International constitutes 20% of the Trefis price estimate for Costco's stock.
3. Ancillary Business constitute 19% of the Trefis price estimate for Costco's stock.

WHAT HAS CHANGED?

1. Costco Falls Short Of Expectations in Q1

For its fiscal first quarter, the retailer reported $3.10 in earnings per share on $53.44 billion in revenue. Analysts had anticipated $3.12 and $54.68 billion, respectively. It should be noted that the miss on revenue is the first miss for the company in 3 years. Meanwhile, the disappointing report on EPS is the first since February 2021. Additionally, comparable sales growth of 6.6% came up just short of the 6.87% consensus and a 6.5% jump in US comparable sales ex-gas also came in just below the 6.58% expectation.

Note: Costco FY'22 ended on August 28, 2022. Q1 FY'23 refers to the quarter that ended on November 20, 2022.

2. Growth in Membership Households

In terms of renewal rates, at the first quarter-end, U.S. and Canada renewal rates were 92.5% compared to 92.4% a quarter ago. Q1 ended with 66.9 million paying household members and 120.9 million cardholders, both up 7% versus last year. Also, paid executive memberships were right at 30 million at Q1 end, an increase of 904,000 during the 12 weeks. It should be noted that Costco's executive members now represent 45% of its paid membership and just under 73% of worldwide sales.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

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 $1230 in 2020 to $1503 in FY 2022. It is an important metric to measure retail sales success and is a factor that drives operating margins. Trefis expects it to increase and reach $2,115 by the end of the forecast period. Increasing new membership signups and higher penetration of executive membership are expected to drive Revenue per Square Foot for Costco US. If Revenue per Square Foot for Costco U.S. increases to $2,250 driven by growing membership, there could be about a 5% upside to our price estimate. On the other hand, if the growth is limited to $1750, there could be about a 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 552 in FY 2020 to 578 in FY 2022. Trefis expects the store count to continue to rise and reach 622 in the long term. In case, the number of Costco U.S. Warehouse Clubs reaches 690 by the end of the forecast period, there could be a 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 has relatively slow growth and reaches 550 by the end of the forecast period.

For additional details, select a driver above or select a division from the interactive Trefis split for Costco at the top of the page.

BUSINESS SUMMARY

Costco is the second-largest retailer in the U.S. and the largest in the warehouse club category with revenues of $227 billion at the end of fiscal 2022. 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. r. In FY 2022, Costco operated 838 warehouses worldwide: 578 in the United States (U.S.) located in 46 states, Washington, D.C., and Puerto Rico, 107 in Canada, 40 in Mexico, 31 in Japan, 29 in the United Kingdom (U.K.), 17 in Korea, 14 in Taiwan, 13 in Australia, four in Spain, two each in France and China, and one in Iceland. The company operates e-commerce websites in the U.S., Canada, U.K., Mexico, Korea, Taiwan, Japan, and Australia. It has approximately 118,900 members including 54,000 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.

Costco's membership fee increased with effect from June 1, 2017. The company hiked the price of its Gold Star membership by $5 per year to $60 and raised its Executive membership fee to $120 from $110. In addition, the company reported that the maximum annual 2% reward associated with the Executive membership will increase from $750 to $1,000. Prior to this increase, the retailer last increased its membership fee in November 2011. As such, with history as a guide, the next membership hike is most likely to come in the first half of 2023.

SOURCES OF VALUE

Higher number of warehouses in the U.S. than internationally

The Core Merchandise U.S. 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 578 warehouse clubs in the U.S. and 260 warehouse clubs internationally as of the end of FY 2022. These warehouses contributed more than 28% of Costco's total merchandise sales.

Increasing penetration of executive members

Executive members pay $120 as a membership fee (as opposed to $60 paid by the other members) to get 2% (maximum of $1000) annual rewards on their purchases. They represent more than one-third of Costco's overall customers and two-thirds of its revenues. Executive membership penetration is on an upward trend and has increased from about 38% in 2009 to close to 45% in FY 2022.

International markets present a huge opportunity

Costco has recently expanded in Iceland, France, and China. It is still expanding 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 56 stores in Taiwan, Korea, and Japan combined and 12 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 Walmart have expressed interest in these markets and are exploring various opportunities to grab a 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 the bulk of its revenues. The retailer earns just 7% ( as of fiscal 2022) 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 omnichannel platform.

KEY TRENDS

Threat of self cannibalization exists

Although the company still has scope for expansion in the U.S., 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.

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 31% of Costco's merchandise at the end of 2022.

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 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.