Shares of Costco Wholesale Corp. (COST, Financial) have plunged, losing all the gains made since the start of the year, after Amazon.com Inc. (AMZN, Financial) announced it is buying Whole Foods Market (WFM, Financial). The market has clearly overreacted to the news, hitting all retail stocks in the process and opening up great opportunities for investors.
Whole Foods accounts for only 1.2% of the U.S. grocery market. The acquisition does help Amazon increase its revenues, expand its retail offering and adds more value to its customers, but to get its 1.2% market share to above 10% is going to take years. It will certainly affect industry margins due to increased competition, but all is not lost for brick-and-mortar stores.
Wal-Mart (WMT, Financial) and Costco are the two companies that have already proved their business models are strong enough to grow despite Amazon’s infringement. Amazon has moved from less than $6 billion in annual sales from North America in 2006 to above $60 billion in 2016. Costco’s annual revenues increased from $64.4 billion in 2007 to $118.7 billion in 2016. Costco more than doubled its annual sales during a period when Amazon witnessed stupendous growth.
Despite the sky-high level of competition in the U.S. retail market, Costco's membership program’s renewal rate continues to hover around the 90% mark. Nine out of every 10 customers believe the membership is worth the money and choose to renew it every year. They could just as easily order from Amazon, but they keep paying for the membership and walking into Costco’s stores year after year.
In its 2016 annual report, Costco said its membership base grew by 7% to nearly 48 million member households. In the U.S. and Canada, 90% of memberships were renewed. Woldwide, 88% of memberships were renewed.Ă‚
There is value in Costco. The membership renewal rate is a huge validation of that.
If any retailers can hold their ground against Amazon, they have to be Walmart and Costco. Walmart has evolved its own strategy to compete with Amazon and is already reaping the benefits of it. Both Walmart and Costco have shown the world it is possible to grow in the retail market no matter where the competition is coming from. As long as customers find value in your offerings, they will keep walking in.
Those companies that do not have a strong enough value differentiator are going to face problems, possibly vanishing over the next five to 10 years. Costco’s shares have dropped sharply over the last few days. If you have been waiting to add to your position, the time is now.
Disclosure: I have no positions in the stock mentioned above and have no intention of initiating a position in the next 72 hours.
