How Valuable Are Costco’s Ancillary Businesses?

by Trefis Team
-5.90%
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Trefis
COST
Costco
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Ancillary or in-store services constitute roughly 20% of Costco’s (NASDAQ:COST) value and is the third most valuable business segment. These services include its food courts, photo centers, pharmacies, optical dispensing centers, gas stations, hearing aid centers, print shops and car washes. We note that Costco’s ancillary revenue per member has grown faster than its store revenue per member, implying that the existing members are using more of these services. In addition, Costco has leveraged its ancillary services to attract new membership signups and encourage frequent customer visits to its stores. [1] Therefore, this business not only directly generates revenues for Costco, but it also helps it sell general merchandise.

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Existing Members Are Increasingly Using Ancillary Services

Although ancillary revenues account for less than 20% of Costco’s total annual revenues, they have grown faster than its overall stores revenues. Their revenue share has increased from 13.5% in 2007 to 18% in 2011, and we expect this trend to continue. This can be attributed to growth in Costco’s membership as well as increased usage of ancillary services by its members. An average Costco member spends about $255 on ancillary services annually. [1]

Over the past five years, the average spending by a Costco member on general merchandise has increased by just 1% annually, whereas the spending on ancillary services has increased by about 10% every year. [1] This clearly implies that while the customers have kept their shopping basket size more or less the same, they haven’t been hesitant in spending more on Costco’s low-priced ancillary services such as food court, pharmacies and gasoline.

Low Priced Gasoline Helps In Different Ways

Costco provides gasoline at lower prices compared to regular gas stations. Costco members are likely to make frequent trips to the stores to take advantage of low-priced gasoline and, in the process, may end up buying other merchandise. In fiscal 2012, Costco’s same store sales increased by 7%, partially driven by frequent store visits by its customers. [1]

Costco’s value proposition becomes even more prominent in event of gasoline price hikes. The retailer reported $1.6 billion in additional revenues in fiscal 2011 due to higher gasoline prices. [1] As gasoline prices rise, more buyers are likely to turn to Costco’s gas stations to save money on fuel. This, in turn, can improve new membership signups. [2]

Pharmacy Benefit Program Likely To Influence New Membership Signup

Last month Costco launched a pharmacy benefit program (PBM) called Costco Health Solutions that will sign contracts with small- and medium-sized businesses. The retailer will provide discounted prescription medicines to employees of its business customers through its in-store pharmacies. [3] The idea behind the program is to make these employees familiar with the cost benefits of shopping at Costco and attract them to become its members.

As of fiscal 2012, the retailer had around 10 million business members. Assuming that about 10%-15% of  the existing business members join this program, there will be around 1 to 1.5 million businesses taking advantage of Costco Health Solutions. If we further assume that a contract with each of these businesses results in 1 to 2 employees becoming Costco members, we are looking at close to 1 to 3 million additional members. Given that Costco earns $1,500 per member annually in revenues, there is an opportunity to grow total revenues by roughly $1.5 to $4.5 billion if its PBM takes off.

Our price estimate for Costco stands at $111, implying a premium of about 10% to the market price.

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Notes:
  1. Costco’s SEC filings [] [] [] [] []
  2. Why Costco benefits from higher gas prices, MSN Money, Mar 5 2012 []
  3. Costco Launches Pharmacy-Benefit Manager Program, Wall Street Journal, Jan 18 2013 []
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