Just the other day, I was reading an article on Amazon (AMZN, Financial) that discussed the deteriorating revenue growth of the colossal online retail giant because of a major shift to digital. Traditionally, a reasonable chunk of Amazon’s revenue has come from its core marketplace unit that sells books, movies, music etc. However, the transcendental shift to digital media has impacted the operating margins of Amazon as well as other online retail players. But, do not be mistaken that this trend has only hit online. To be specific, this trend has majorly hit offline brick and mortar retail stores like Walmart (WMT, Financial) and Target (TGT, Financial) and pushed down their revenue growth in a big way.
Though the advent of e-commerce has been mighty, one offline retailer that has been able to comfortably sustain its revenue and margins and come on top of the crisis is Costco (COST, Financial). In fact, Costco is one of my favorite stocks because of its superior business model and dedicated focus on customer and employee happiness. The company operates membership warehouses that offer a wide variety of branded and private-label products in a range of merchandise categories in no-frills, self-service warehouse facilities. The company has been a shareholders’ darling and much to the veracity of it, the company has delivered solid gains to its investors. Consider this: Costco has appreciated around 200 percent over the last five years.
A recent report from Deutsche Bank (DB) has mentioned that Costco will stand out from among retailers when it reports its October sales metrics. "While retail remains volatile, we believe Costco has produced another solid mid-single-digit comp in October with strength in food sales, particularly fresh, and consistency in softlines and hardlines categories," Paul Trussel of Deutsche Bank wrote. The analyst expects Costco to report core same-store-sales gains of 6.5 percent, roughly in-line with September's results and slightly higher than the 12-month average of 5.8 percent. Including gas, foreign exchange fluctuations and inflation impacts, the analyst expects a headline comp gain of 5.0 percent in September.
Making the moves
In the fourth quarter results, membership fees came in at $768 million or 2.21%, that’s up 7% or $52 million year-over-year from $716. It’s down 4 basis points as a percent of sales. Again, we had strong sales in the quarter. Additionally, the company saw strong renewal rates in the membership division rounding up to 91% in the U.S. and Canada, and little over 87% worldwide. The company also continues to enjoy strength in the Executive member program with continued new signups. Speaking of the new signups, the fourth quarter saw a little over 2 million new signups in the company. This was helped, of course, by strong new signups and a few overseas openings in Australia, Korea and Spain over the past year.
After the past quarter results came out, a good number of analysts expressed their concern over the demography of Costco’s members, which is skewed towards the older generation as people from the 35+ age bracket love to buy from the company. The reason behind this is Costco’s relentless service, variety of labels (both branded and private) and the ease of purchasing goods. However, the younger folks have still not made it big in Costco’s books. But the good part is that the company knows it and has started acting on it as well. For eight days, the company ran a promotional campaign on Living Social for new members, with the purchase of a full price $55 membership plan. This promotion on Living Social was meant to provide extra value to the new members. Since LivingSocial users tend to be younger, this offer is bringing in millenials who otherwise might not have joined Costco.
E-commerce is the thing
At the very onset of this article, I mentioned about the advent of e-commerce and how it has bruised the margins of brick and mortar retailers. Well, like other offline retailers, Costco has also commenced its foray into the online retail world and as per data, Costco’s totaled shy of $3 billion in the last year. Also, the e-commerce business has been growing at an annual rate of 18%-19% and this is approximately double of company’s overall growth rate. Costco is trying out a few strategies to drive e-commerce growth. One tool is simply expanding to new countries. Costco only operates e-commerce sites in the U.S., U.K., Canada, and Mexico today. However, it has warehouses in several other countries, including Japan, South Korea, and Australia. Costco plans to add 1-2 countries to its e-commerce operations in the coming year.
Takeaway
Of all the retailers including the online players as well, Costco has become my favourite because of its sustainable business model and its strong focus on maintaining the quality of services. Furthermore, Costco has a number of strategic partnerships with companies in different industries to offer benefits to their members. Though the valuation of the company may be a tad bit higher with a trailing P/E of around 29, its business model and string entry to the e-commerce world justify the price.
