Buy Costco Sell Wal-Mart And Target

| About: Costco Wholesale (COST)

Summary

Costco's policy regarding employees is about to give them an edge over other retailers and put them in a position to steal market share.

The Fight For Fifteen movement is attempting to increase the minimum wage to $15 and the movement has had numerous successes already in large states like California and New York.

Costco will hardly be affected as they already pay most of their employees more than $15.

Why Costco is the best retailer in the U.S.

Executive Summary

There is a new political trend going on in the United States. Workers are demanding $15 minimum wages through the Fight for Fifteen movement. The increase in wages will severely impact the profitability of retail companies like Wal-Mart (NYSE:WMT) and Target (NYSE:TGT), since their business model relies on squeezing suppliers and employees. In this analysis, I will show that Costco's (NASDAQ:COST) profitability will decrease by a mere $0.02 to $0.03 per share per dollar increase in wage.

On top of this, Costco already pays a minimum wage of $13 and an average wage of almost $21 per hour. Therefore, I believe that Costco is currently the single best long-term choice for those that are seeking exposure to the retail market and therefore definitely deserves a premium valuation.

A two to three cents earnings per share decline is actually impressive when we compare it to competitors, which may see abysmal bottom line declines. The narrative is that a minimum wage must equal a living wage. A living wage is a wage that covers basic costs of life. A living wage has been quantified at $15 an hour.

This political trend has manifested itself in the Fight for Fifteen movement. This movement has had numerous successes in several states. The states of California and New York have committed to set the minimum wage at $15 an hour. Other states are watching this to assess whether they should follow suit. The movement is very active. They are currently organizing protests across 340 different cities in the United States. These protests are supposed to take place on 29th of November. Their Facebook page 'Fight for $15' currently has 316k likes and they are posting multiple times a day.

Note: This analysis is part of my 'Pay Up: Employees get their due as shareholders get the shoe' series. The world is changing and as a result a major new trend will be, I feel, the significant increase in minimum wages, which will result in severe cuts in profitability for companies that exploit employees for their competitive advantage. However, some companies will actually not be affected as they already pay more than is currently being demanded (more than $15 hour).

Company Overview

Costco Wholesale Corporation is a $66 billion company that operates membership warehouses. It offers branded and private-label products in a range of merchandise categories. Roughly, 73% of the Company's sales are in the US, with Canada accounting for 14% and international sales accounting for the difference of roughly 13%.

Time frame

As stated in the first paragraph, the Fight For Fifteen movement aims to increase wages across the nation. The state of California and New York have recently committed to paying a $15 minimum wage by 2022. Other states across the nation like Florida are closely watching the developments in California and New York. If the developments in California and New York prove beneficial, this could add additional momentum to the movement.

The minimum wage and how this relates to COST

COST has 143k U.S. full and part-time employees and each employee earns approximately $10.9k income on average. This makes it the highest earner per employee. Costco also has a notoriously different approach to how it treats it employees. Target and Wal-Mart have continuously tried to keep their average wage as low as possible, while Costco has chosen to give their employees a generous pay.

Their reasoning is that great employees work a lot harder and better than good employees. In fact, according to Costco founder Kip Tindell, 1 great employee equals 3 good employees. Costco currently has a U.S. employee minimum wage of $13 per hour and has an average hourly wage of $21 per hour. To clarify, (starting) employees are paid at least $13 per hour, but the vast majority earn $21 per hour. The $13 minimum wage is the result of a recent raise from $11.50 an hour and it cost the Company about 2 cents earnings per share on an EPS of $5.33.

The fact that this is only costing Costco a mere 2 cents per share is because most of its employees are already making significantly more than $13 an hour. This means that only a few employees are benefiting from this new policy as most are already getting paid more than this.

Costco's policy is certainly showing results. The Company has the lowest turnover among retailers.

These facts support the claim that higher wages will not be detrimental to businesses. Keep in mind that Costco entered the U.S. in 2012 and now has 506 warehouses in the U.S. In other words, Costco has been able to realize terrific growth rates in income (+37.5% since 2012) and sales (+19.7% since 2012) while paying a high average wage.

Of course, there are still plenty of people that say that this is because Costco has a completely different business model than retailers like Wal-Mart and Target. Richard Berman, a lobbyist that is hired by businesses to attack consumer, safety and environmental groups, even went as far as to state that "It's like saying, 'Why does Microsoft pay more than Starbucks?'" If one is interested in Richard Berman and his work, you can click here and here for 'Dr. Evil'.

Conclusion and Valuation

Costco is the retailer that is best positioned to handle this political trend. In fact, it is the only discount retailer that will not suffer a significant loss in earnings as a result of the movement. If the recent increase in wages of $1.50 cost the Company $0.02 to $0.03 cents a share, an additional $2 increase will cost the Company $0.027 to $0.04 per share. Based on the ttm EPS is $5.36 the additional wage increase to a $15 minimum wage will cost the Company 0.55% to 0.75% of its current EPS.

If we assume that the market will value COST according to today's multiple of a 28.5 P/E, the stock would be valued at $151 to $150.76. As of the time of this writing, the stock trades at $151.82. However, I believe that COST would actually appreciate were the nationwide $15 minimum wage were to manifest. The reason for this is that investors that seek exposure to retail, will be flocking to the retailer that is best positioned to absorb these additional costs. COST is the retailer that will see the least amount of decline in earnings per share, while others like WMT and TGT could face significant declines. You can find my analysis of these companies by clicking on my profile.

I believe that this has additional positive effects for Costco. As retailers like Wal-Mart and Target revamp and reconstruct their business models and/or adjust their cost structure, Costco will possibly be able steal market share, because it will not be occupied by deflecting a significant decline in income. This is why I feel that the current valuation of a P/E of 28.5 is more than justified for those who are seeking exposure in the retail industry.

Further outlook

As other retailers start seeing higher and higher declines in profitability, the market will start to value Costco at a premium, because the additional cash inflow to the stock will naturally propel the stock higher and thus increase the valuation. While I consider Costco to be the best of the bunch for the reasons outlined above, I find that there is too little upside currently so I would like to wait to add on lower prices.

If COST were to grow by a mere 2% for the rest of its life cycle, the wage increase would result in a flat YoY growth in 2022, while competitors would be reporting declines in income. This would highlight the fact that COST would be the best of the bunch and I believe this could result in (institutional) investors selling WMT and TGT to buy COST.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in COST over 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.