Costco: A Retail Sweet Spot?

Oct.25.13 | About: Costco Wholesale (COST)

Despite of the weakness in the U.S. retail industry due to lower consumer spending, warehouse giant Costco Wholesale (COST) managed to report strong results in its fourth quarter of fiscal year 2013. The reason behind this growth lies in its business model; Costco provides goods to its customers at a discounted price as compared to other retailers. This provides customers with a competitive shopping experience, fostering incremental sales. Further, Costco has laid down its expansion plan for fiscal year 2014, which will have a significant impact on its income.

Global expansion

In the fourth quarter of fiscal year 2013, Costco's U.S. stores witnessed 5% growth in same store sales, and international same stores sales grew 7%. With the sales witnessing an upsurge, the company plans to expand its store count in fiscal year 2014. Currently, Costco Warehouse has 637 warehouse locations globally, and it plans to add 36 new warehouses in fiscal year 2014. Last year, the company opened 26 new warehouses, and it opened 16 in fiscal year 2012. The number of new store openings is increasing every year, depicting the company's growth.

As far as its fiscal year 2014 plan is concerned, it will open the 36 new stores in an equal proportion in the U.S. and international markets. In accordance with this full year expansion blueprint, Costco plans to open approximately 15 stores in the first quarter of 2014, out of which 10 stores will be opened in the U.S. and rest in international markets. Costco is expanding equally in both markets, the U.S. and internationally, because its business model is sustainable in the current weak economic scenario prevailing in the U.S. Further, its international market is generating high sales, as depicted in this quarter's results.

On the other hand, its competitor, Target (TGT), is expanding outside the U.S., owning to profits decline in U.S. stores. With this, Target is expanding aggressively in the Canadian market, with a plan to open 124 new stores by the end of this year. Since Target started this plan, it has opened 68 new stores, and it will add 23 new stores by the end of this month. With these expansion plans, Target is facing problems with its bottom line, but it Canadian expansion will act as a tailwind in the long run.

Expansion is increasing membership

Costco Wholesale is membership only retail, allowing its members to purchase merchandise at discounted prices. Its membership fees play a vital role in its income statement, as more than 70% of its operating income is generated through this. The weak scenario is enhancing the company's membership network, as membership allows consumers to buy products at a discounted price, in comparison to other retailers.

In the first half of 2013, approximately 1.6 million new members were added in its membership network, and in its fourth quarter, new membership increased 4% quarter over quarter. Currently, there are 70.2 million members, which pay up to $110 per year to shop at Costco stores and online. In addition to new members joining Costco, renewal of its annual membership is also witnessing an upsurge.

We believe that its members are expected to increase with the expansion plans discussed above. The company is increasing new stores at robust growth rate, which will expand its presence. This will increase customers' access to stores, leading towards incremental memberships. According to Trefis, its total membership-card holders are expected to increase from the current 70.2 million to 75.8 million by the end of 2015, enhancing its membership fees.

Competitor's strategy

Sam's Club, a subsidiary of Wal-Mart Stores (WMT), is also a membership only retail like Costco Wholesale. It is continuously adopting strategies to entice customers to buy more from it stores. In its previous growth strategies, Sam's Club improved the food quality and added gift prizes for its customers to attract the traffic towards its stores. However, these strategies failed to foster strong results due to Sam's Club's lack of ability to implement these strategies.

Currently, Sam's Club has a new strategy to add incremental merchandise during the holiday season to attract traffic towards its stores. The chain is adding 132 new merchandise items, up by 135% a year ago. On the other hand, Costco Wholesale is focusing on its expansion strategy, as discussed above.

In addition to this, Costco has an edge over Sam's Club regarding same store sales. Sam's Club stores witnessed growth of merely 1.7% quarter over quarter in comparison to Costco's overall 6%. Despite its various strategies, Sam's Club sales are expected to remain flat in the next quarter.


In our previous article, we included the dividend history of Costco Wholesale, and we found this stock isn't an appropriate pick for income investors due to its low forward dividend yield of merely 1.10%. Let's analyze whether this stock is an appropriate pick for value investors or not. We have used Price to book ratio and return on equity as valuation multiples for analyzing this stock.

Price to book ratio

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Currently, Costco's price to book ratio is 4.67, and it has increased over the last 5 years, as depicted in the chart above. This implies that its stock price is moving in accordance with the company's book value. So, let's see whether Costco is generating profits with the capital invested by its shareholders.

Return on Equity

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Presently, Costco's return on equity is 17.45%, which has witnessed an upsurge as depicted in the chart above. A low price to book ratio and high return on equity indicates an undervalued stock, which is an appropriate pick for income investors. Along with this, both the multiples are moving in a similar pattern, depicting that the company is trading in accordance with its intrinsic value and is generating high returns, leading towards capital appreciation for value investors.

A stock to buy

Costco Wholesale's discounted products act as a growth driver during weak consumer spending. The company is expanding its footprint globally, which will lead towards higher membership fees. Along with its strong fundamentals, its valuation is also attractive, and Costco Wholesale is a suitable stock for value investors. Henceforth, this stock is a buy.

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.

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Shweta Dubey, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article