Costco An Attractive Retail Market Player

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Mar 24, 2015
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With an improving economy and buoyant consumer sentiment, retail and wholesale companies have good reason to smile. It also shows on the books of companies like Kroger Co (KR, Financial), Costco Wholesale Corporation (COST, Financial) and Wal-Mart Stores Inc. (WMT, Financial) who have all shown revenue growth at varying rates despite the fall in oil prices, considering fuel sales form a decent chunk of their revenues. While there are headwinds expected in the short term that will affect the operations of these supermarket giants, based on strong fundamentals, I make a pitch to buy Costco on a dip as a long term investment.

Expansion plans, physical and virtual

Costco plans to open at over 30 new locations this year, adding to its existing tally of more than 670 stores in 10 countries spread across four continents. Of the 20 new locations whose openings are planned in this fiscal itself, 10 are in international markets, showcasing the aggressive approach the company is taking to expand its footprint outside the domestic U.S. market. It is also a good thing insofar as the international business typically has higher margins when compared to those in the U.S.

While expanding its brick and mortar network, the company is also making inroads in online retail. Costco Online has shown good performance for the company in Canada, United Kingdom and Mexico markets in the last quarter. But more significantly, Costco has tied up with Alibaba T-Mall, an e-commerce platform in China and this has contributed $6.4 million in revenues in the first month of operation alone. Given the $2 trillion potential of the Chinese retail market, Costco has done well where its peers have failed.

New credit card deal

Costco has announced that it will be severing its partnership with American Express (AXP, Financial) for co-branded credit cards which will be replaced by Visa (V, Financial) cards issued by Citi (C, Financial) from April 1 next year. While it still remains to be seen what it will mean for its existing customers who hold Costco rewards cards, it is sure to reduce the credit card processing fees that the company shells out every year. If forced to move from one credit network to another, its existing rewards members might not be a very happy lot but the lower cost to the company will certainly bring cheer to investors.

Looking after investors

Given its negotiating power with financial institutions from which it raises debt, Costco enjoys among the lowest interest rates for any borrower. Despite that, it is not very usual for a company to borrow close to $1 billion so that it can reward its investors with a special dividend. Costco did precisely that when it paid out $2.2 billion in a special dividend at the rate of $5 per share last month. This showcases the company’s determination to treat its investors well by rewarding them for their faith in the company as illustrated in our last article titled: ‘Best Buy, Costco Announce Special Dividends’. The company also bought back $92 million worth of stock in the quarter gone by.

Some headwinds

The new debt taken on to pay the special dividend could create some liquidity issues for Costco in the short term. While the company is making a push in the online retail space, its main business is still brick and mortar stores, and these physical stores are under an ever-increasing threat from their online counterparts. A strengthening US dollar also doesn’t bode well for the company as it expands its international operations.

Buy on a dip

The stock seems decently priced at its current value of around the $150 mark. However, if it dips below $140, it would make for a very good purchase.