Costco - Good At Controlling Costs And Keeping Good Employees

May.24.13 | About: Costco Wholesale (COST)

Costco's (NASDAQ:COST) stock price has been in an upswing this week. It recently hit an all-time high. It's evidently assumed by many that next week's third-quarter earnings will be positive and upbeat. That event follows its over 10 year rise in price. The stock's underlying floor seems to be rising compared to even last week. Sure, there have been ups and down to the price during this ride; but the market seems to be realizing the underlying fundamentals of COST's business. The stock's 50-day moving average is currently $104.6. The company has a market cap of $46.801 billion and a price-to-earnings ratio of 24.03. They have also declared a quarterly cash dividend on Costco common stock and approved an increase from $.275 to $.31 per share, or from $1.10 to $1.24 per share on an annualized basis. The quarterly dividend is payable May 31, 2013, to shareholders of record at the close of business on May 17, 2013. says that last quarter, COST had on hand 7.6 billion dollars of inventory at the end of the last quarter; which would fuel only one month of sales. But this inventory is financed by the vendors , not COST. This implies that COST does not require as much working capital as other players in the club area to be successful. Indeed, it would seem that by the time the bill for the supplies must be paid, it has already been sold. This really allows their gross margin rate to be strong, without spikes caused by non-performing inventory.

COST is well known in the industry for their "investing in price" strategy. They feel that continuing low prices will bring in more traffic than sales events where prices dip like attempted by failing retail giant J.C. Penney (NYSE:JCP). And this is fundamental to all the other parts of the puzzle that compose COST.

COST's operating expenses are rather low. For 2012, they were $9.5 billion which is just 9.6% of sales. This could compare to Amazon (NASDAQ:AMZN) which spent around 23% of sales. One may argue that Amazon's case is not typical due to infrastructure costs as they ramp up and grow; but that would miss the point. COST focuses on reducing cost any way it can for the business. It is a player in the war going on between retailers and the credit card people over what is termed "Swipe fees", the cost of actually using their cards. Interestingly, they are cooperating with Wal-Mart (NYSE:WMT) in this effort.

Low costs are what gives the "invest in price" strategy its muscle. COST can compete with online retailers or anyone else on price; a strategy that most brick-and-mortar retailers can't implement see Best Buy (NYSE:BBY), But COST can do that (and has done it) rather well. Of course, most of the profits that COST generates come from membership fees, rather than the low (or zero) profit merchandise that they sell. So, member retention becomes a rather key metric. Right now, it's about 90%. COST must be doing something right.

But there is another metric that seems striking when you look at it. And that is the total number of SKUs that COST has in its warehouses. pegs the SKUs at about 3,800 compared to Sam's Club 5,000 SKUs and the 7,000 SKUs stocked by BJ's. They also share a note from UBS analyst Jason DeRise to his clients that notes that "This means its (Costco's) SKU's are extremely productive, averaging over $750 in revenue per SKU per store per week. This is 2.5x Sam's Club's rate and ~5x BJ's rate." Costco's SKU metric is 60 times higher than the average supermarket, 70 times higher than supercenters and 200 times higher than the average drug store.

COST also seems to be a haven for the socially-aware investor, especially compared to Wal-Mart. Whereas WMT has been shown to have wages that are very low, poor working conditions, and almost non-existent worker benefits, COST has taken a totally differing approach. They spend on their employees, which leads to better motivation, attracting better workers in the first place, and keeping them from leaving.

The New York Times noted in a 2005 article that COST paid their employees about 42% higher wages than competitor Sam's Club. Perhaps more tellingly, health insurance issued by COST reached 96% of the company's workforce. WMT only covered 44% of their employees. If an employee has health insurance with an employer, they may be far more likely to stay with them. And reducing employee turnover leads to a stable work environment respected by the customers.

COST reported a 4 percent growth in April comparable sales, with monthly net sales climbing 7 percent to $7.98 billion, from last year's $7.48 billion. They also said that the changes in gasoline prices and foreign exchange rates had negative impacts on comparable sales for the four-week period, but slightly positive impacts for the 35-week period. Excluding these effects, 4-week comparable sales for the total company went up 6 percent.

COST is currently having a small legal war with Tiffany & Co. (NYSE:TIF) over COST's use of the "Tiffany setting" phrase for some of its jewelry. COST asserts the phrase is generic; but it seems to be on shaky grounds in its arguments. Whatever the outcome is, it's not expected to directly affect COST's bottom line in a significant way.

If one is seeking a high-growth stock, COST may not be it. Currently, their growth is single digit, though the earnings are growing a bit faster. But the growth they have shown thus far seems to be sustainable over time, based on Costco's track record.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.