While most retailers including Wal-Mart (WMT) and Target (TGT) struggled in their recent quarter due to the prolonged cold and payroll tax hikes, Costco‘s (COST) growth remained steady. The retailer’s revenues and comparable store sales (CSS) grew by 7.9% and 7% respectively, in Q3 fiscal 2013.  However, including the impact of lower gasoline prices and foreign currency fluctuations, CSS growth was 5%. Going forward, we believe that Costco’s growth will remain on track as its membership base continues to grow. Its strong e-commerce channel and rapid international expansion will provide strong support. Also, the improving housing industry in the U.S. will complement the growth of Costco’s hardlines business, which accounts for about 16% of its revenues. 
Growing Membership Base
Historically, the main driver for Costco’s revenue growth has been the increasing number of members as the average spend per customer has grown by just 1% annually over the last five years.  To attract customers, the retailer offers products at lower prices than its competitors due to low product markups, strong negotiating power over vendors and lower frill costs.  
Increasing New Membership Signups & Executive Members
Over the last few years, Costco has seen a noticeable increase in the number of new members. While the retailer added 2.3 million members in 2009, more than 4 million customers signed up in 2011.  Over 1.6 million new members joined Costco during the first two quarters of fiscal 2013.   Furthermore, it saw a rise of 19% in new membership signups in fiscal Q3, as compared to the previous year.  This can be attributed to strong signups in Japan stores and additional discounts offered on gasoline and groceries during the quarter.  Cautious consumer spending on the account of recent payroll tax increase also contributed to the growth. We believe that due to its appealing business model, more customers will join Costco.
Executive members pay $110 as membership fee (as opposed $55 paid by the other members) to get 2% (maximum of $750) annual rewards on their purchases.  They represent one-third of Costco’s overall customers and two-third of its revenues. The proportion of these members in Costco’s overall membership base has been rising historically and this trend is likely to continue in the future. 
Improving Renewal Rates & Visits Frequency
Costco’s membership renewal rates have been improving for some time now as customers are returning to Costco, troubled by the sluggish economy. While the membership renewal rate for North America remained flat at 89.7% during Q1 fiscal 2013, it improved slightly to 89.8% in the second quarter and 89.9% in the third quarter.   The improving renewal rate despite a 10% rise in membership fee (November 2011) is an encouraging sign for Costco.
The company regularly changes the brands it offers by buying the brands that have larger inventories to get more discounts.  As a result, customers always find something new at its stores, which encourages frequent visits. During the quarter, the retailer’s comparable store sales growth mainly came from a 5.5% increase in the frequency of customer visits. 
Strong E-commerce Channel
The online retail market in the U.S. has grown rapidly since 2004 and the long term outlook remains optimistic. Forrester forecasts that online sales in the U.S. will grow 13% to $262 billion in 2013 and reach $370 billion by 2017.  This presents a huge growth opportunity for Costco’s online sales as well. During the quarter, the retailer’s e-commerce revenues increased by 20%, backed by its e-commerce strategy, website re-platforming and mobile apps.  Costco offers distinct products on the e-commerce site to keep its customers interested.  About 80%-90% of its products offered online do not overlap with the stores inventory, which enables to retailer to maintain its store traffic alongside growing online sales.  Moreover, there is a large opportunity for Costco to push its online sales in international markets, as its reach is currently limited to the U.K. 
Costco’s revenue growth in international markets has been significantly faster than that in the U.S.  The company saw good response in Australia and Asia, with 20,000 – 60,000 membership signups on the opening day of Asian stores.  Over the past five years, the retailer has opened only five international stores annually. However, given the success and the growth potential, the retailer plans to open 16 such stores in fiscal 2013. In Q3 fiscal 2013, four of the five stores opened were in the markets of Japan, Mexico and the U.K. Costco plans to add another six locations in the next quarter.  The company appears to be building a strong foundation for its international business, which is likely to payoff in the longer run.
Improving Housing Industry
The housing industry in the U.S. appears to be improving. The Standard & Poor’s Case-Shiller home price index reported the best gains in the last seven years.  Twenty cities in the U.S. were tracked for this index, and the housing prices rose in every one of them. This is positively impacting consumer confidence, making them feel wealthier and putting them in a buying mood.  According to a report by Conference Board, the U.S. consumer confidence improved to a five-year high in May 2013.  For Costco, this directly impacts the sales of its hardlines, which mainly include home related products. The company stated that its hardwares, home & garden, and consumer electronics were among the strongest performers during Q3.  Improving housing industry is a sign of recovering economy, and this will complement Costco’s broader growth in the future.
Our price estimate for Costco stands at $113, which is slightly ahead of the market price.
- Costco’s SEC filings
- Costco’s Unorthodox Strategy To survive The Big Box Apocalypse, Business Insider, Mar 7 2013
- How Costco Became The Anti-Wal-Mart, The New York Times, July 17 2005
- Costco’s Q1 fiscal 2013 earnings transcript, Dec 12 2012
- Costco’s Q2 fiscal 2013 earnings transcript, Mar 12 2013
- Costco’s Q3 fiscal 2013 earnings transcript, May 30 2013
- Inside Costco: Secret’s Of America’s Favorite Stores, abc news, March 29 2010
- U.S. Online Retail Sales To Reach $370B by 2017, Forbes, Mar 14 2013
- Costco’s Q2 fiscal 2013 earnings transcript, Mar 12 2013
- House Prices Rise, Putting Country In Buying Mood, The New York Times, May 28 2013
- Consumer confidence strongest in over five years in may, Reuters, May 28 2013
Disclosure: No positions