Costco’s Value Focus And Membership Growth Support $110 Stock Despite Weak Economy

by Trefis Team
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The strong customer adoption of the warehouse shopping model and increasing membership income continued to drive Costco’s (NASDAQ:COST) Q1 fiscal 2013 results. The sluggish economic growth in the U.S. has forced the consumers to look for low cost shopping alternatives. Warehouse clubs such as Costco, BJ’s Wholesale Club and Wal-Mart’s (NYSE:WMT) Sam’s Club provide that option. In addition to this, the proportion of executive members is increasing and that should aid Costco’s membership income as well as overall sales.  While the retailer seems to be doing well in the U.S., international operations are also growing quickly as evidenced by the rising comparable store sales. [1]

See our complete analysis for Costco

Weak Macroeconomic Conditions Driving Customers To Costco

Due to the persistently high unemployment rate in the U.S. and slow economic growth, shoppers are looking for ways to save money. This will continue to drive customers to warehouse clubs, and Costco is the strongest of the lot. Costco also provides gasoline at discounted prices, thus enhancing its appeal to value conscious customers and creating another reason to drive to its stores.

Even if economic growth picks up, customers may still prefer shopping at Costco stores due to cost benefits. Costco maintains its strength on this front by offering private label brands. These products have low prices, higher margins and are comparable in quality to national brands. [1] One of the latest additions to its pool of private label brands is Green Mountain Coffee (NYSE:GMCR) coffee cups. [2]

The retailer has been increasing the penetration of private label brands within its merchandise by about 0.5% to 0.75% annually. [3] Furthermore, as the economy picks up, more businesses will emerge and this will complement Costco’s growth. A significant proportion of Costco’s members is small business owners who tend to buy in bulk. So either way, the future prospects for Costco look good.

Higher Penetration Of Executive Members

Executive members, who account for about one-third of Costco’s total members and two-third of its sales, are most the valuable customers for the retailer. Executive members pay around $110 annually as opposed to $55 paid by the other members. As a result, executive members are given additional benefits worth 2% of their annual purchases (maximum $500), which can be redeemed at Costco stores. [1] The penetration of executive members increased from 33% in fiscal 2009 to 38% at the end of fiscal 2012. [1]

An increase in executive members will provide strong support to Costco’s future growth. The fact that these members pay a higher membership fee implies that they tend to buy a lot more in order to take advantage of ‘2% annual reward’. Additionally, the overall membership renewal rates remained strong and stable at 89.7% in the U.S. and Canada, and 86.4% worldwide. [3]

International Business Growing Faster

Costco’s international business contributes only about 20% to the retailer’s revenues. However, the retailer is performing better in the international markets as it is a unique and a distinct business phenomenon that offers cost savings.

In Q1 fiscal 2013, the comparable store sales of Costco’s international business increased by 9%, which was more than the growth in the U.S. [1] Over the past 5 years, Costco has opened only 5 stores annually in the international markets. However, given the success and the growth potential, the retailer plans to open 16 stores internationally in fiscal 2013. [3] We believe that it makes sense for Costco to expand more aggressively in international markets given their huge potential, and the fact that the retailer is already doing well in the U.S.

Our price estimate for Costco stands at $111, implying a premium of about 15% to the market price.

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  1. Costco’s SEC filings [] [] [] [] []
  2. Green Mountain Rises On Private Brands K Cups For Costco, Bloomberg, Nov 2 2012 []
  3. Costco’s Q1 fiscal 2013 earnings transcript, Dec 12 2012 [] [] []
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