Costco Wholesale Corporation (COST, Financial) operates membership warehouses that offer its members low prices on a limited selection of branded and selected private-label products in a range of merchandise categories. It buys the majority of its merchandise directly from manufacturers and routes it to a cross-docking consolidation point (depot) or directly to its warehouses. Its depots receive container-based shipments from manufacturers and reallocate these goods for shipment to its individual warehouses, generally in less than 24 hours. Its warehouse format averages approximately 143,000 square feet. Its warehouses operate on a seven-day, 69-hour week. It carries an average of approximately 3,900 active stock keeping units (SKUs) per warehouse in its core warehouse business. Many consumable products are offered for sale in case, carton or multiple-pack quantities only. Costco Mexico, its 50%-owned joint venture, operated 32 warehouses as of August 29, 2010.
Market Cap: $33.6 billion
Business Predictability: 5 stars
Industry: Discount, Variety Stores
Analysis:
Costco is one of the world’s most successful retail stories. A pioneer in the warehouse club membership, Costco has vowed to pass along the typical mark up to its customers. In return, the company secures loyal customers and membership fees which provide a steady source of recurring revenue. In addition to the unique savings in the warehouse format, Costco’s buyers have a strong sense of what their customers want and need.
Costco more than makes up for thin profit margins with massive sales volumes and high-velocity turnover. The company carries just 3,800 active SKUs per club — a fraction of the 60,000 items stocked at most mass merchant superstores. This enables Costco to exert a meaningful amount of power over suppliers. Costco's merchants have an excellent track record selecting only highly sought after merchandise, helping to drive inventory sell-through rates that are 35% faster than Wal-Mart. The result is incredibly high inventory turns and very efficient cash conversion. Costco's tremendous efficiency leads to above average returns on capital — well above its industry peers.
The company is doing a great job at capturing incremental market share from other retail channels as consumers still look for ways to stretch their budgets during a post-recessionary environment. Superior merchandising, unrivaled supply-chain efficiencies, and tremendous power over its suppliers provide Costco with consistently positive economic returns.
The company is very selective about its expansion strategy, as the warehouse club needs specific demographics and population density to support it. However, warehouse clubs have started to gain acceptance among international consumers, suggesting that Costco is in the early stages of a global growth story. Costco's competitive prices stem from its tremendous bargaining power, a no-frills shopping environment, supply-chain efficiencies, and a modest average markup in the low-double-digits (compared with average markups in the high-teens at Walmart WMT and in the mid-20% range at grocery stores).
The firm also reduces handling costs by purchasing full truckloads of merchandise from manufacturers and storing merchandise on sales floors rather than in central warehouses. Self-service store formats and modest marketing requirements help to minimize operating costs, allowing Costco to pass the savings to consumers in the form of lower prices. Costco continues to generate healthy increases in club traffic, even as it laps impressive member acquisition growth during the thick of the recent downturn. Renewal rates have not suffered much when Costco has raised membership fees in the past, suggesting that Costco holds a fair amount of pricing power over its customers. In fact, it is expected that they will pursue a fee increase on its members relatively soon. It is expected that that Costco will retain a significant portion of the market share it has already captured from traditional retail channels. Costco's low-price strategy inherently leads to thin profitability. As previously discussed, Costco converts its inventory into cash before payments are due to its suppliers, leading to negative working capital requirements — very positive for a retailer.
One can expect Costco to continue to generate positive economic returns over an extended horizon given its relatively stable business model and proven franchise. Given the heavy capital requirements involved, the company’s square footage expansion is at a steady mid-single-digit pace — lower than square footage growth in the recent past. However, with just 580 clubs across the globe and the early success of warehouse clubs in overseas markets, Costco has attractive global growth opportunities. Based on the company’s estimates, there may be an opportunity to exceed 1,000 warehouse clubs over an extended horizon, with international expansion being Costco's primary growth engine going forward. Compared to Sam's Club's larger store footprint, Costco dwarfs it in sales and volume. In fiscal 2009, Costco generated about $135 million per club ($950 per square foot), compared with about $78 million at Sam's Club ($590 per square foot).
Rather than a pure square footage expansion strategy, Costco is also pursuing a mix shift in its customer base. By targeting a more affluent customer base with its upper-end merchandise mix, Costco effectively avoids price wars with rivals — a strategy that has worked well, especially when competing with retail bellwether Walmart. While overall membership numbers have remained stable, membership fee income should increase due to price increases. As for same-store sales — comps have been growing in the low single digits.
Valuation:
Ratios – P/E (ttm) 24.4X
P/S .41X
P/B 2.9X
EV/EBIT 13.7X
Discounted Cash Flow Analysis:
Financials:
Risk:
- Economic risks
- Consumer spending
- Input cost inflation
Conclusion:
Costco is a top-of-the-line, world-class retailer including warehouse clubs and non-club stores. The club concept has plenty of growth potential — especially internationally. Whether a growth or value investor, this company represents a core holding in most portfolios.
The Buffett-Munger screener is designed to find Buffett-type investments with extraordinary profitability, consistency and future prospects. Our monthly Buffett-Munger Best Bargains Newsletter picks one stock from the screener. Our in-depth analysis shares with you why younger Buffett and Munger would like this stock. If you are a premium member, you can download it here. If you are not, we invite you for a 7-day Free Trial.
Market Cap: $33.6 billion
Business Predictability: 5 stars
Industry: Discount, Variety Stores
Analysis:
Costco is one of the world’s most successful retail stories. A pioneer in the warehouse club membership, Costco has vowed to pass along the typical mark up to its customers. In return, the company secures loyal customers and membership fees which provide a steady source of recurring revenue. In addition to the unique savings in the warehouse format, Costco’s buyers have a strong sense of what their customers want and need.
Costco more than makes up for thin profit margins with massive sales volumes and high-velocity turnover. The company carries just 3,800 active SKUs per club — a fraction of the 60,000 items stocked at most mass merchant superstores. This enables Costco to exert a meaningful amount of power over suppliers. Costco's merchants have an excellent track record selecting only highly sought after merchandise, helping to drive inventory sell-through rates that are 35% faster than Wal-Mart. The result is incredibly high inventory turns and very efficient cash conversion. Costco's tremendous efficiency leads to above average returns on capital — well above its industry peers.
The company is doing a great job at capturing incremental market share from other retail channels as consumers still look for ways to stretch their budgets during a post-recessionary environment. Superior merchandising, unrivaled supply-chain efficiencies, and tremendous power over its suppliers provide Costco with consistently positive economic returns.
The company is very selective about its expansion strategy, as the warehouse club needs specific demographics and population density to support it. However, warehouse clubs have started to gain acceptance among international consumers, suggesting that Costco is in the early stages of a global growth story. Costco's competitive prices stem from its tremendous bargaining power, a no-frills shopping environment, supply-chain efficiencies, and a modest average markup in the low-double-digits (compared with average markups in the high-teens at Walmart WMT and in the mid-20% range at grocery stores).
The firm also reduces handling costs by purchasing full truckloads of merchandise from manufacturers and storing merchandise on sales floors rather than in central warehouses. Self-service store formats and modest marketing requirements help to minimize operating costs, allowing Costco to pass the savings to consumers in the form of lower prices. Costco continues to generate healthy increases in club traffic, even as it laps impressive member acquisition growth during the thick of the recent downturn. Renewal rates have not suffered much when Costco has raised membership fees in the past, suggesting that Costco holds a fair amount of pricing power over its customers. In fact, it is expected that they will pursue a fee increase on its members relatively soon. It is expected that that Costco will retain a significant portion of the market share it has already captured from traditional retail channels. Costco's low-price strategy inherently leads to thin profitability. As previously discussed, Costco converts its inventory into cash before payments are due to its suppliers, leading to negative working capital requirements — very positive for a retailer.
One can expect Costco to continue to generate positive economic returns over an extended horizon given its relatively stable business model and proven franchise. Given the heavy capital requirements involved, the company’s square footage expansion is at a steady mid-single-digit pace — lower than square footage growth in the recent past. However, with just 580 clubs across the globe and the early success of warehouse clubs in overseas markets, Costco has attractive global growth opportunities. Based on the company’s estimates, there may be an opportunity to exceed 1,000 warehouse clubs over an extended horizon, with international expansion being Costco's primary growth engine going forward. Compared to Sam's Club's larger store footprint, Costco dwarfs it in sales and volume. In fiscal 2009, Costco generated about $135 million per club ($950 per square foot), compared with about $78 million at Sam's Club ($590 per square foot).
Rather than a pure square footage expansion strategy, Costco is also pursuing a mix shift in its customer base. By targeting a more affluent customer base with its upper-end merchandise mix, Costco effectively avoids price wars with rivals — a strategy that has worked well, especially when competing with retail bellwether Walmart. While overall membership numbers have remained stable, membership fee income should increase due to price increases. As for same-store sales — comps have been growing in the low single digits.
Valuation:
Ratios – P/E (ttm) 24.4X
P/S .41X
P/B 2.9X
EV/EBIT 13.7X
Discounted Cash Flow Analysis:
| 10-year growth | Margin of Safety |
| >15% | 10% |
| 10% | -7% |
| <10% | -12% |
Financials:
| Book Value / Share | Return on Equity | Return on Assets | |
| Dec 2010 | $24.98 | 12.0% | 5.5% |
| Dec 2009 | $22.99 | 10.8% | 4.9% |
| Dec 2008 | $21.25 | 14.0% | 6.2% |
| Dec 2007 | $19.73 | 12.6% | 5.5% |
| Dec 2006 | $19.78 | 12.1% | 6.3% |
| Dec 2005 | $18.80 | 12.0% | 6.4% |
| Dec 2004 | $16.48 | 11.6% | 5.8% |
| Dec 2003 | $14.33 | 11.0% | 5.5% |
| Dec 2002 | $12.51 | 12.3% | 6.0% |
| Dec 2001 | $10.81 | 12.3% | 6.0% |
Risk:
- Economic risks
- Consumer spending
- Input cost inflation
Conclusion:
Costco is a top-of-the-line, world-class retailer including warehouse clubs and non-club stores. The club concept has plenty of growth potential — especially internationally. Whether a growth or value investor, this company represents a core holding in most portfolios.
The Buffett-Munger screener is designed to find Buffett-type investments with extraordinary profitability, consistency and future prospects. Our monthly Buffett-Munger Best Bargains Newsletter picks one stock from the screener. Our in-depth analysis shares with you why younger Buffett and Munger would like this stock. If you are a premium member, you can download it here. If you are not, we invite you for a 7-day Free Trial.
