Costco's Membership Model Is The Perfect Shield

| About: Costco Wholesale (COST)
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The exponential growth of online retailers has impaired the metrics of brick and mortar stores. However, Costco has maintained its revenue by following a membership model.

Wal-Mart's dividend shows that the retail colossus is having a hard time in combating the competition from online retailers. As such, it is also stepping up its online game.

A no-frills shopping experience provided by Costco has the potential to draw customers in the weak economy as of today and can prove to be a game-changer for the company.

There is no doubt about the fact that a sizeable chunk of the World population has been touched by the Internet and that people have now gone online for most of the things like shopping, medical help, and even raising funds for start-ups. While, this is definitely a positive step in terms of technology advancement, this shift to the online World has done reasonable damage to the offline retail industry comprising of huge retail chains like Wal-Mart (NYSE:WMT), Target Corporation (NYSE:TGT) and Costco (NASDAQ:COST). However, Costco has been above the rest in terms of delivering consistent results because of its robust membership model, high employee morale and effective cost management.

Reasonable numbers

For the second quarter of 2014, Costco's earnings slid to $1.05 per share from $1.24 per share, a year ago. Though the company's last year earnings was impacted by a $52 million or $0.14 per share tax benefit, the current earnings is still a few notches below the prior year period. Sales were up by approximately 6% in Q2 on an overall basis and 3% on a comp basis. As the management pointed out, the four-week period between Thanksgiving and Christmas saw weak sales as compared to previous year mainly because of a snowy weather prevalent at that time.

The might of e-commerce

Besides the large collection of items that online websites boast, these e-commerce websites have also introduced the customers to a plethora of discount deals and other membership benefits. As such, customers have become more focused on the value-for-money aspect with regard to their purchases and scouting for the best deals. Costco is a fantastic alternative in brick and mortar retail stores, whose membership model bestows privileged benefits to customers at reasonable cost and thus, matches up with the might of e-retailing.

Costco's membership model is a hit

The data for the second quarter shows the effectiveness of Costco's membership model. New membership signups in the second quarter company-wide were up 13% y-o-y while the overall membership fees was up by 4% y-o-y to $550 million. Also, the paid executive memberships stood to the right of 14 million in the quarter, approximately an increase of 2,00,000 since the end of first quarter; it is significant to note that this type of membership represents approximately two-thirds of Costco's total sales.

I have given all these numbers to highlight quite an important point that a major chunk of this retail giant's revenue comes from membership fees as compared to product sales, unlike other chains like Wal-Mart and Target Corp. This is one of the reasons that Costco's quarterly result is notches better than Wal-Mart, which reported a decline of 0.4% in same-store sales for 14 weeks ended on January 31st. The reason that Wal-Mart's earnings beat consensus estimate by a whisker was the fact that analysts had lowered their expectations after the announcement of guidance warnings made by the company.

Wal-Mart's dividend announcement was a shocker

Wal-Mart's performance was affected by similar factors as Costco including harsh weather conditions, fluctuation in currency and strengthening presence of online retail enterprises. However, the event that actually jolted the investor community was an increase of a mere 2% in annual dividend, a considerable aberration from Wal-Mart's strong dividend history. As per past data, this dividend increase is the smallest in the last 10 years and could imply a negative foreseeable future.

This being said, it should also be factored that brick and mortar retailers faced certain generic unfavourable conditions in December and this poor performance could be a one-off case. It is actually impressive to see that Wal-Mart is at least stepping up its game in e-retailing, which is under its control and can be leveraged. For instance, this report points out the company's plans to push for an e-retailing business model in India similar to that of Amazon (NASDAQ:AMZN) and eBay (NASDAQ:EBAY). This is a significant step from the company considering the fact that it failed to establish brick and mortar stores in the country after hanging there for almost six years.

Final words

It is evidently clear that Costco's strength revolves around it membership model and the ability to provide a no-frills shopping experience to its privileged members at a low price. Additionally, the retail giant is making strides in the organic foods business, a well growing segment of the grocery industry. As Richard Galanti pointed out in the earnings call: The organic business is big and growing fast and will provide a robust revenue stream for the future.

To sum it up, Costco is an ideal candidate for investment for the following reasons:

1. The threatening growth of online retail business has already done good damage to the brick and mortar stores. However, Costco's strong membership model has enabled it to build and sustain its revenues, making it the best pick amongst all the retail chains.

2. For the quarter, comparable store sales grew by around 3%, in spite of a weak economy and unfavourable business conditions. The primary reason behind this growth is the huge discount i.e. around 55% that members can avail of by purchasing from warehouse clubs. Thus, low prices and commendable quality have been consistently upheld by the company through its warehouse purchase model and it is going to be a key element of Costco's future growth.

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.