Costco (COST, Financial), one of the world’s leading warehouse retailers, has been going through a rough patch of late. Low oil prices, a stronger U.S. dollar and food deflation have hurt the company’s sales numbers, and the pain of transitioning from American Express to Visa only added to their misery. But despite all the troubles, Costco still managed to grow its revenues from $116.19 billion last year to $118.72 billion.
Costco’s biggest strength is a business model that focuses on building loyalty. The fee that Costco collects from its members filters straight to the bottom line, allowing the company to keep expanding its product lineup and keep offering the best prices possible to its users. Since the membership fee guarantees its profitability, Costco can afford to operate at cost if needed.
Costco’s membership renewal rate has consistently stayed around the 90% mark, making it clear that brand has a solid adoption rate once people enjoy the Costco experience. Clearly, the product offering is good enough to make 9 out of 10 people keep coming back for more.
Total membership fees for fiscal 2016 stood at $2.646 billion while operating income reached $3.672 billion. Costco’s operations have brought in the additional billion in operating income. Due to its membership model and strong loyalty, of all the top retail companies, Costco is possibly the one that has enough bandwidth to take and dive into e-commerce. But the company has so far refused to go strongly into the e-commerce route, preferring to continue with the open more warehouses philosophy.
To be fair to the company, Chief Financial Officer Richard Galanti did address this issue, saying e-commerce is a huge problem in the future.
“And what's keeping CFO Richard Galanti up at night? 'Everybody in the world never wanting to leave their house and only typing stuff to order and get it at the front door,' he told analysts Thursday. “ - Bloomberg
Unfortunately, that realization hasn’t translated into any kind of strong action, and Costco’s e-commerce footprint remains abysmal by any standard. Costco’s online operations accounted for 4% of their net sales in 2016, compared to 3% in 2015 and 2014. Costco’s net sales was $116.073 billion in 2016, which means the company’s online operations brought in $4.642 billion.
Less than $5 billion in annual e-commerce sales is far lower than the $19 billion Amazon has added to its top line last year. With more than 86 million members in its fold, Costco could have easily added robust e-commerce operations into the mix. The company may have had to accept lower bottom line results in return, but the market has already shown that it is ready to sacrifice bottom line growth as long as the top line is increasing at a rapid rate.
Despite the huge runway and the precedence to prove it can be done, Costco keeps refusing to understand its own strengths and remains risk-averse.
Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.
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