Costco Wholesale Corporation.

Costco | Wholesale | Corporation | 29th July 2022 | Virtual Wire

 

Picture


Company Overview

The Costco Wholesale Corporation is a forty-six-year-old, multi-billion-dollar global retailer that operates as a membership warehouse club to provide its members with competitive prices on a wide variety of products, primarily groceries, across its 829 warehouses in the US, Canada, Europe, and Asia. Costco’s business model is centered around affordable products, with an 11% markup rate, that are purchased in bulk to compensate for the razor-thin margins. As a result, they spend no money on advertising to save around 2% on the costs of advertising and keep prices low, in order to protect their relationship with their customers, especially their target market of middle to high-income economic actors. Costco is also a publicly traded company under the ticker: COST, on the Nasdaq, where the top individual shareholders are the current CEO, Craig Jelinek, Charles Munger, vice chairman of the board of directors of Berkshire Hathaway Inc., and Patrick Callans, the executive vice president of Administration for Costco, and the top institutional shareholders are the Vanguard Group, BlackRock Inc., and State Street Corp. Costco provides its 114.8 million members with exclusive access to the services of its numerous subsidiaries, which mainly comprise Costco Wholesale Logistics, Costco Wholesale Membership Inc., Costco Wholesale Industries, Kirkland Signature, Costco Auto Program, Costco Travel and Costco Services, specifically its gasoline stations, optical and hearing aid centers and pharmaceutical services.









On March 17, 2020, Costco acquired the logistics company Innovel Solutions, now known as Costco Wholesale Logistics, for $1bln to gain access to its 90% coverage of the US and Puerto Rico, and exploit its warehousing, transportation, installation, and home delivery services. As a result of the acquisition, Costco was able to expand its capacity for serving members, improved delivery times, and bolstered its e-commerce operations, especially for big and bulky products. At the end of 2020, Costco reported that e-commerce sales represented approximately 6% of net sales, and, as of Q2 FY 2022, e-commerce now represents over 12% of total net sales, making CWL and crucial integrant of Costco’s operations and future.


Costco Wholesale Membership Inc. represents a branch of the Costco Wholesale Corporation that administers the memberships that are provided to customers. Costco offers three types of membership: Executive, Business and Gold Star, each providing access to on-site warehouses and savings on Costco’s e-commerce site, in addition to the individual benefits of each level. Membership plays a pivotal role in Costco’s business model, as it provides customer loyalty, reduces shrinkage, and provides a stream of income. Not only does Costco’s subscription model attract consumers, with the exclusivity of its services, but it creates a loyal community as customers are more likely to justify the membership fees they are paying by shopping at Costco, as shown by its member renewal rate of 91% in the US and Canada and 89% worldwide, by the end of 2021. Memberships indirectly combat shrinkage, as shoplifters will have to expend $60 a year to steal from a facility that has security guards at its entrances and exits. As of Q4 FY 2021, Costco reported $3.9 bln in revenue from membership fees, which mainly represents profit due to the minimal costs of labour and promotional mailing needed to manage membership.


Costco Wholesale Industries and Kirkland Signature represent two divisions of the Company that specialize in the production of a substantial portion of Costco’s inventory. Costco Wholesale Industries superintends manufacturing business, specializing in special food packaging, optical laboratories, meat processing and jewellery distribution. Kirkland Signature is America’s largest consumer packaged goods brand in terms of the $59 bln it generated in 2021, as a result of Costco’s co-founder, Jim Sinegal, introducing a high-quality, ubiquitous private label that would challenge America’s low lifespan labels and the high-quality labels from overseas, in the mid-1990s. Ultimately, both Costco Wholesale Industries and Kirkland Signature are intrinsic to Costco’s business model of consistently providing consumers with high-quality products.


Both the Costco Auto Program and Costco Travel function under the common premise of training negotiators to haggle with travel vendors and prominent car manufacturers to lower their prices and then offer those discounted rates to their customers. The Costco Auto Program trains provide low prices for members to buy, lease, or trade in various types of vehicles at lower prices. Costco also provides members with access to their Member Advocacy Group so that they can complain if the dealership is not treating them properly, thus allowing for a comfortable, non-confrontational shopping experience. While neither of these programs provides Costco with any more streams of revenue, both serve as a key component of Costco’s business model and are integral to the appeal of a Costco membership.


Costco Services encompass a variety of different services that can be utilized at the disposal of members. Costco’s preeminent service is its gasoline business, which represents about 9% of total net sales, as of 2021. According to a 2019 report, the revenue generated from Costco’s ancillary businesses was $30 bln, meaning that they both serve a significant role as a revenue stream and a marketing element to entice potential members.

Industry Overview


The consumer staples sector comprises companies that sell essential products, especially, foods and beverages, household goods, and hygiene products, along with alcohol and tobacco products. As of March 27, 2022, the consumer staples sector boasts a total market cap of $2.7 tln, total earnings of $99.2 bln, and total revenue of $2.2 tln. The high and consistent demand for these products deems the sector non-cyclical, making it impervious to the fluctuations of the business cycle. The sector has reportedly outperformed most other sectors since 1962, over the past 10 years it has had a return rate of 8.20% annually and has always outperformed other sectors during the last three recessionary periods, thus ensuring investors with consistent growth. However, the sector is also known to have slow growth and limited highs as it typically underperforms during periods of economic growth. With the risks of aggressive interest rate hikes and the persistence of the Russia-Ukraine Invasion, and inflationary growth, this defensive sector will likely experience a surge of growth from the number of investors who flock to it during these times of volatility.

Costco specifically belongs to the wholesale club market, of the consumer staples sector, with a market share of 55.5%, followed by Sam’s Club, owned by Walmart, and BJ’s Wholesale. The warehouse club industry has demonstrated steady growth of approximately 3.4% in revenue, from 2017-2022. This industry is defined by the wide array of amenities and necessities it sells, usually in substantial quantities at discounted prices, to members. Albeit slow, compared to the overall sector, the wholesale club market is expected to grow by 0.7% in 2022; however, it is likely to retain its position as the 20th largest industry in the US market due to its remarkable performance, relative to other industries, in the past five years.


Competitive Positioning

Costco faces extreme competitive pressures from its competitors in the wholesale club space, BJ’s Wholesale and Sam’s Club, and from companies in the retail industry, such as Kroger, Amazon, Target, Walmart, and several other companies. However, Costco’s unique business practices, experience, and prominence in the wholesale club industry have granted it numerous competitive advantages to drive customers towards its doors and away from its competitors. Like BJ’s Wholesale and Sam’s Club, Costco operates on a membership program that requires customers to purchase a membership status to shop in stores or gain discounts on online purchases.


The membership program provides the overall industry with a distinctive advantage over all other retailers because it pressures members to take advantage of their membership and patronize wholesale clubs, rather than other retailers, for specific products. On top of the stable source of revenue and low advertising costs, Costco’s membership model is supported by various programs and strategies it employs to achieve its retention rate of roughly 90%. In this day and age, brick-and-mortar stores are reaching a status of obsolescence, as consumers prefer the convenience of online shopping. While Costco has recently been focused on expanding upon its e-commerce trade, it remains faithful to the survival of brick-and-mortar stores, evinced by its decision to open 28 more stores in 2022. In addition, Costco and the Consumer Retailing sector have consistently outperformed eCommerce giants like Amazon and the Online Retail sector over the past three years,

comprising the entire timeline of the COVID-19 Pandemic and when online retail was at its peak. Thus, proving that brick-and-mortar is far from being obsolete, especially with the tactics that Costco employs to provide shoppers with a rush of oxytocin for every second they stay in stores. As aforementioned, Costco provides significant discounts on products since it sells in bulk, and psychologists have discovered that not only does the discovery of discounts increase levels of the “feel good” hormone, oxytocin, and increase happiness by an average of 11%, but it also encourages shoppers to spend more and indulge in that sense of saving money. Unlike every other retail store, Costco purposely does not label their aisles to force shoppers to search each aisle for Costco’s “triggers and treasures,” triggers being household staples that comprise 75% of its inventory, and treasures being desirable products that constitute the other 25% of its inventory. This tactic amplifies the most notorious tactic used by almost all other retail stores: impulse purchasing, as it forces customers to explore every inch of the warehouse and encounter both the triggers and treasures Costco has to offer.


On top of that, Costco saves and gains money from having fewer brands on its shelves, as a monumental 2000 study found that consumers will often walk away from the confusion of having to choose from a multitude of brands for the same product. A crucial tactic that Costco uses, that justifies the relevance of its brick-and-mortar store format, is its use of ancillary businesses that allows customers to cross off countless tasks on their to-do lists since they can buy groceries, furniture, entertainment systems, etc. while also visiting the beauty salon, filling up their car with high-quality gas, receiving their medication, printing documents, visiting the optometry centre, or booking any flights. Finally, unlike other retailers, Costco offers free samples that have shown to boost sales up to 2,000%, according to a 2004 study, to stimulate demand or even prompt members to visit the store.

Additionally, Costco and its wholesale club competitors rely on a pricing strategy of purchasing and selling their goods in bulk at discounted prices and razor-thin profit margins to attract current and potential members.


However, the two prominent factors that distinguish Costco from its wholesale club counterparts are its ownership of its ubiquitous private label, Kirkland Signature, and its high ESG risk ratings relative to its competitors. Kirkland Signature plays a vital role in Costco’s business strategy, as its superlative products are exclusively sold at Costco, thus attracting both old and new members. In terms of revenue, Kirkland Signature is one of the most prevalent CPG labels, surpassing Nestlé, Procter & Gamble, PepsiCo, and Unilever, and achieving a value that is more than twice that of Walmart’s Great Value brand. As aforementioned, Kirkland Signature achieved its success as a result of Jim Sinegal’s vision for a brand that produced a variety of products that were consistently superior to national and overseas brands, with a minimum of a 20% reduction in price.

Additionally, Costco has more control over its daily operations as it relies on fewer suppliers, can easily choose which items to put on shelves, and has a low inventory capacity of only 4,000 stock keeping units (SKUs), per store, compared to its competitors. As a result of the limited shelf space and the prominence of Kirkland Signature products, Costco will save more money, on top of the inputs, to maintain low prices. Ultimately, Kirkland Signature plays a pivotal role in Costco’s ability to outperform its competitors, as its ubiquity has made it a household brand that is synonymous with economical and high-quality goods while creating a more efficient business model for Costco. Costco along with the Costco Auto Program and Costco Travel represents a significant competitive advantage that Costco has, over most of the retail sector, that would make Costco an easy stock pick for investors to include in their portfolio, rather than its competing wholesale clubs.


Costco’s breadth of services is unmatched by most of the retail sector, thus attracting customers to its membership programs to take advantage of its list of travelling programs to cover all travelling desires, as it offers economical automobiles, affordable gas, tire installation, and reasonably priced tickets for travelling, medical needs, with its pharmaceutical and optical programs, along with insurance, home and business-related services. Costco is roughly estimated to provide the most services for its members. Therefore, Costco is clearly dominating other wholesale clubs in terms of the number of services it provides, which makes its membership program significantly more attractive to potential consumers, thus making it a more attractive company for customers to patronize instead of other companies in its sector.

Finally, one factor that distinguishes Costco from most other companies, including its competitors, is the lenient work environment it fosters in its warehouses, recognized by Forbes as #17 on America’s Best Large Employers; in other words, the highest-ranking retail and wholesale company. Costco’s invigorating and supportive employee culture is rooted in Jim Sinegal’s propensity to “do the right thing,” resulting in a mutualistic relationship between the employer and employee, as Costco pays a minimum wage of $17 per hour and offers numerous benefits, and in return employees passionately complete their work and share ideas to improve efficiency, curtail costs, and improve member and employee experience on their own volition. twice-yearly










While Costco may not pay its employees the most, it offers affordable health care coverage, a company-sponsored retirement plan, an employee stock purchase program, twice yearly Extra Checks (bonuses) for long-tenured hourly employees, competitive paid sick, vacation and leave policies, and additional benefits for hourly workers, such as its 50% full-time ratio. These factors have resulted in Costco having one of the highest retention rates in its industry, an industry that is notorious for its abysmal working conditions. Thus, Costco saves a significant amount of money, since human capital is arguably the most exorbitant cost of a business, enhances the experience of the consumers who get to interact with the employees, and it improves Costco’s ESG ratings and reputation.


Financial Analysis



Valuation

We firmly believe that Costco Wholesale will achieve new heights of prosperity by 2023, as it expands into foreign markets and challenges local competitors with its innovative business model. Additionally, Costco’s recent unveiling of plans to vertically integrate Kirkland Signature, starting with its operation of Lincoln Premium Poultry, suggests a brighter future for Costco, as it continues to lower prices, attract more consumers, and deliver satisfactory experiences.

  • 2023 revenue estimate: $232.38 bln.

  • 2023 net income estimate: $6.09 bln.

  • 2023 EPS: $13.71/share.

  • 2023 Target Price COST: $609.62/share (+6%).

Investment Risks

  • Overvaluation: numerous investors have deemed Costco as an overvalued company, and with the recent conditions of the economic climate, shareholders may feel more comfortable in selling their shares in Costco, thus causing a declining share price.

  • Inflation: Costco is ubiquitously known for its low prices, but with rising inflation, Costco will either have to endure the marginal profit margins and temporarily lose money, or it will have to raise its prices and potentially lose a considerable portion its members.

  • Increasing interest rates: Costco’s recent attempts to expand into foreign markets will most likely be encumbered by the Fed’s recent efforts to raise interest rates, in order to combat inflation.

  • Insider trading: recently, two executives and a director have sold their shares in the company, and when combined with its already inflated stock price, investors may be convinced to sell their shares as well.


Investment Summary

Costco’s finances, business model, domination of the wholesale club industry, noticeable presence in the larger sector, and future opportunities have all proved themselves worthy of a buy recommendation. Over the past four years, Costco has consistently shown substantial improvement and growth, as well as a strong inclination to reinvest in the future of the company. Costco’s business model primarily relies on its sale of cheap goods, in large quantities, and its membership model. Combined with Costco’s renowned in-store experience, a cycle is created where members constantly patronize the store to justify the money they spend on their membership, and in return, the members continue to renew their membership in order to gain access to Costco’s discounts and variety of services.


Costco currently holds a whopping 55.5% market share of the wholesale club industry and owns the most successful private label, Kirkland Signature, in the market. Kirkland Signature’s ubiquitous success goes hand in hand with Costco’s market share, as customers will most likely be attracted to the high quality and low prices of its products, thus perpetuating the cycle of membership. Finally, Costco’s plans to expand into foreign markets and vertically integrate Kirkland Signature, thus lowering the price of production, could significantly boost Costco’s success and increase investor confidence.


Environment, Social, and Governance (ESG) Considerations

Costco currently remains in the 68th percentile of the 28,485 companies that were ranked by CSRHUB for their ESG commitments. This, makes Costco, both, a lucrative and scrupulous investment, especially when considering BJ’s Wholesale is ranked in the 34th percentile and Sam’s Club is not even being ranked due to insufficient data.


Environmental

  • Scope 1 and 2 Emissions Reduction is a five-part decarbonization strategy that Costco developed in 2021 to collect and analyze data on carbon, water and waste management, to find solutions, reduce carbon emissions through energy and refrigeration projects, shift towards renewable energy, and obtain renewable energy certificates after exhausting all other cost-effective reduction pathways, in order to reduce CO2e emissions by 45% by 2035 from a 2020 base year

  1. Scope 1: reduce refrigerant emissions with Global Warming Potential by 30% by 2030.

  2. Scope 2: increase purchasing of renewable electricity to 100% by 2035.

Costco has also adopted a 10-Point Climate Action Plan, guided by the Sustainability Accounting Standards Board framework and the ESG Advisory Council, to pursue relevant UN Sustainable Development Goals (SDGs)

  • Costco has already completed a prodigious portion of its objectives and is on track to finishing most of the remaining objectives by the end of 2022, even though the UN set a timeline to fulfil the SDGs by 2030.

Societal

As of FY 2021, Costco’s Charitable Contributions Committee dedicated $58 mln to:

  • Expand vaccine access with the Vaccine Equity Initiative by donating $1 mln.

  • Combat hunger, by donating $3.5 mln in cash grants and 70 mln pounds of food.

  • Address race and class barriers, by committing $35 mln to the BEDF and EOCLF.

  • Curtailing student loan debt, by donating $5.8 mln towards educational opportunities.

  • Promote literacy, with the Costco Employee Volunteer Reading Program.

  • Provide access to adequate healthcare by donating to hospitals, cancer research, etc.


Corporate Governance

  • Costco’s executive officers and board of directors have consistently displayed superlative leadership, with their Corporate Governance Guidelines, Code of Ethics, and other documents that outline Costco’s zero-tolerance policy for any kind of malicious conduct.

  • As aforementioned, Costco has a dedicated ESG Advisory Council and Charitable Contributions Committee to explicitly demonstrate their acknowledgement and attempts to address societal and environmental issues, thus fostering proactive public relations to avoid controversies.

  • Costco is exceptionally diverse, as indicated by its 2022 Comparably diversity score.













8 views1 comment