A Bright Future Ahead For Costco

by Trefis Team
-8.36%
Downside
529
Market
485
Trefis
COST
Costco
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Strong customer adoption of the warehouse store shopping model, the strengthening of its e-commerce platform and vigorous expansion plans were the highlights of Costco’s (NASDAQ:COST) recently released Q4 fiscal 2012 earnings. The retailer reported revenues of $31 billion for the quarter, which was an increase of 14% compared to the same period last year. [1] It appears that given the slow growth of the economy, customers are realizing the value of purchasing at discount warehouses such as Costco. We expect this trend to continue in the U.S. We further expect this same value proposition to fuel Costco’s international growth, especially in markets where customers are likely to be value conscious.

See our complete analysis for Costco

Shifting Market Trend Will Drive Revenue Growth In The U.S.

As U.S. shoppers are looking at ways to save money due to sluggish growth in the economy and a high unemployment rate, warehouse clubs such as Costco and Wal-Mart’s (NYSE:WMT) Sam’s Club seem to be viable options. This trend has resulted in an increase in the traffic and subsequently, an increase in the membership which is likely to continue in the future.

The membership fee income in Q4 fiscal 2012 was 18% more than what it was in the same quarter last year. [2] The main reasons behind this increase were the 10% increase in the membership fee for the U.S. and Canada customers and a 2% increase in the number of executive members. [2] The new membership signup also increased by 2% and Costco reported an improvement of 0.1% in the membership renewal rates. [2] All of these figures point to the aforementioned argument regarding the shifting trend.

Slight Fall In Margins, Nothing To Worry About

Costco’s strategy is to drive traffic by keeping the prices competitive. The retailer registered a marginal decline in its gross margins as the figure decreased from 10.54% in Q4 fiscal 2011 to 10.51% this quarter. [1] The non-food categories such as hardlines and softlines which recorded a high revenue growth in this quarter had lower margins as compared to the fresh food and food & sundries items. The groceries have higher margins but their revenue growth contributes less than hardlines and softlines.

Although the difference in the margins is quite insignificant in the context of positive revenue growth, the razor thin margins will not allow Costco to take a margin hit to a greater extent. With food inflation already pushing Costco’s margins to the edge, the company will have to focus its attention on promoting high margin products and will have to exploit the market trends to increase its customer base.

International Market Can Prove To Be More Prolific

Apart from 2011, when Costco consolidated Costco Mexico, the international expansion has been quite moderate. The retailer opened an average of 5 stores every year outside the U.S in the last 5 years. [1] The Costco stores in the international markets are slightly smaller than the U.S. stores, but they generate almost similar revenue per square feet. In fact, as per the company filings, the revenue per square feet for the international markets was about 10% more than the revenue per square foot for the U.S. operations for the fiscal year 2012. [1] Moreover, the revenue contribution of the international operations to Costco has increased from 20% in 2009 to 30% in 2012. [1]

Costco’s focus has now shifted a bit more towards international expansion as the market has proved to be lucrative. Out of the 30 stores that the retailer has planned for fiscal 2013, more than half will be in the international markets. [1] The retailer plans to open 5 stores in the international markets within the first quarter of fiscal 2013. [1]

What Does This Mean To Wal-Mart And Amazon?

While the shifting trend of shopping towards the warehouse clubs will help Costco, it might have a slight negative impact on Wal-Mart and Target. The trend might facilitate a gradual shift of customers from regular retailers to Costco, Sam’s Club and BJ’s Wholesale Club. Even if Wal-Mart’s customers shift to its own Sam’s Club, it will have a negative impact on the overall margins as Sam’s Club is a low margin business. Although in this case margin decline might exist, it will not be significant enough to cause a noticeable impact on Wal-Mart. However, the effect on retailers such as Target can be greater which lack both, the low price advantage and the warehouse club business model.

Costco is also looking to strengthen its e-commerce platform in order to tap the online channel. The online sales registered a revenue growth of 14% in Q4 fiscal 2012 as compared to the same period last year. [2] The retailer still needs to travel a long way before it can compete with the online giant Amazon (NASDAQ:AMZN) in its area of strength. However, Costco’s consumer electronics and small electrical appliances recorded a moderate revenue growth. Given the changing shopping trend, the consumers might prefer buying these items from the warehouse store rather than online.

We are in the process of updating Costco model in the light of recent earnings, and will have an update ready soon.

Our price estimate for Costco stands at $101, roughly same as the market price.

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Notes:
  1. Costco’s SEC filings [] [] [] [] [] [] []
  2. Costco’s Q4 fiscal 2012 earnings transcript [] [] [] []
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