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Costco: An Expensive Valuation Shouldn't Be a Deterrent for Investors

May 29, 2014 | About:
kcpl

kcpl

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Warehouse club operator Costco (COST) came out with impressive results. The stock has been impressive on the market, trading close to its 52-week high and at a rich valuation. Also, investors seem confident of its outperformance in the future. Let us see how Costco manages to maintain this momentum.

The Road Forward

Costco’s solid business model should prove to be a growth driver for the company as it is attracting many new customers to its warehouse. The company has a lot of growth opportunities going forward. A slight change in its operations, as well as premium adjustment, can make it a solid investment.

Costco counts on membership fees for growth and operating margins. This is not only a growth driver to the revenue, but also a solid indicator of the brand's strength. Also, investors are attracted to the company's membership fees strategy as seen in a 12% increase in the membership fees. Also, the number of new members rose 19% in the last quarter.

The success of this strategy can be seen by the fact that Costco managed to add 1.6 million new members in the first two quarters. In addition, Costco is also seeing a strong 93.9% renewal rate, indicating that despite adding new members, the company is also managing its existing customers well.

Expansions

Costco is focusing worldwide to improve its profitability. It is seeing great traction in new memberships from countries like Japan. The company is now focusing on stretching its arms to other countries. The company had 627 warehouses at the end of the previous quarter, out of which 448 were in the U.S. and Puerto Rico, 85 in Canada, 33 in Mexico, and others spread across the UK, Japan, Taiwan, Korea and Australia.

The expansion strategy by Costco isn’t showing and signs of stopping. The company saw square footage growth of 4.5% this year, up from last year’s 3%, which is impressive. Further, the company still has more room for growth in the North American market. This fact is supported by the recent announcement of 28 new openings in the U.S. and Canada. The company is paying attention to the domestic markets as well. If it focuses more on the international front, it can stretch out its arms further, driving more growth opportunities from some of those potential markets.

Ecommerce Focus

Besides working on its physical expansion, Costco is also focused on improving its ecommerce business, Costco Online. With Costco Online, the company has penetrated regions in the U.S., Canada and the UK as of now. With the success of Costco Online in these regions, which can be seen by a 20% jump in traffic, the company is focusing on expanding Costco Online to other geographies too. However, Costco Online has stiff competition from Amazon.com.

In the ecommerce space, Amazon.com presents stiff competition to Costco Online. Features like two-day shipping, unlimited video streaming and access to the Kindle Library for just $79 a year are attractive, and can drive customers away from Costco Online. However, Costco Online has a cost advantage on Amazon.com’s service such as Amazon Prime.

Also, since Costco’s members pay a membership fee, they would be utilizing it to make purchases from the warehouses or its ecommerce portal rather than looking somewhere else.

Also, Costco is well known for its work culture. Costco takes care of the employees well, and has high wages. Its exemplary employment policy is a key reason for employee retention. This helps Costco to save cost. With this characteristic, Costco has a competitive advantage over Wal-Mart, where the employees are paid low wages and in the case of theft, the loss is recovered from employees’ wages.

Conclusion

Thus, Costco, like a socially responsible company, ticks all the right boxes and looks like the Mr. Right which you can always count upon to deliver on all fronts.

Considering everything, Costco has a lot of room to grow, its brand is as solid as ever, it keeps everyone happy — be it customers, employees, or investors — and as such, a premium valuation shouldn’t be a deterrent to investing in it.


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