Is Costco Itself The Next Great Bargain It Offers Its Customers?

Summary

• Amazon has become a deeper threat to Costco with its acquisition of Whole Foods.
• Amazon has to integrate the higher cost structure of Whole Foods into its low-cost pricing model.
• Customer loyalty and a history of surviving challenges indicate Costco can thrive under the competitive threat.

With the acquisition of Whole Foods (WFM) by online giant Amazon (AMZN), Costco (NASDAQ:COST) has seen its stock fall from approximately $180/share to about $158/share as of the time of this writing. In a previous article, I argued that Costco’s greatest competitive threat was Amazon and not Sam’s Club. The acquisition of Whole Foods means that Amazon poses a greater threat since Amazon now has brick and mortar stores by which they can compete more directly in the grocery category, estimated to be about 35% of Costco’s sales. With the uncertainty that Amazon has created in the grocery marketplace, Costco’s strengths and weaknesses should be re-evaluated before taking advantage of the lower stock price.

The increased competitive threat by Amazon is undeniable. The Whole Foods acquisition provides Amazon with brick and mortar grocery stores in most all the largest metropolitan areas in the U.S. Additionally, customers who have little time to shop can rely on the Amazon Echo to order items on command, and the company can have this food delivered, in some cases faster than it can be picked up at Costco. That said, investors should also not assume that Amazon’s acquisition will be an unqualified success. While Amazon competes aggressively on price, Whole Foods has a reputation for high prices, earning the moniker “Whole Paycheck,” as lower-priced competitors started stocking organic foods and reducing their market share. It’s still unclear whether Whole Foods can bring its prices to Amazon’s competitive level.

And despite the new challenge, many of Costco’s strengths remain. It has a long history of holding up well against competitive threats. Costco’s sales growth has a long track record of year over year growth going back over a decade, with the only exception being 2009 which saw a 1% drop in sales. Though growth has slowed over the last two fiscal years, it remains positive. Additionally, the compound annual growth rate (CAGR) stands at 7.2%, stronger than its competitors in the grocery space, other than Amazon. This shows its ability to both attain new customers and maintain the loyalty of its existing customers, which is holding strong with a renewal rate of about 90% before its membership price increase in June. Finally, Costco has strong brand loyalty with Kirkland signature, with many products winning great reviews from both customers and critics. In fact, the golf balls available at Costco were referred to as “the most coveted ball in golf” and Costco had to pull them from their website for a time because they had sold out. The price to earnings (P/E) ratio, which has fallen substantially since Amazon announced its Whole Foods acquisition, has a forward P/E of just under 25 as of the time of this writing, making it a compelling buy for those who believe that Costco will thrive in this tougher competitive environment.

Amazon’s Whole Foods acquisition is undoubtedly taking direct aim at one of Costco’s strengths, food sales, further deepening the threat posed to Costco by Amazon’s same-day delivery. Despite this challenge, with its low prices for high-quality foods and other goods, Costco has strengths in brand and member loyalty that cannot be ignored. And given its history of strong financial performances in the face of economic downturns and competitive threats, Costco is well-positioned to remain a strong competitor and benefit should Amazon fail to deliver. While the merger creates uncertainties for both entities, the lower stock price and Costco’s innate strengths could make Costco itself one of the store’s most enticing bargains.

Analyst’s Disclosure: I/we 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.