Costco: Stock of the Week

Is this Costco’s secret to lasting retail success?

Andrew Willis 09.05.2023
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Andrew Willis: Have you ever noticed that Costco (COST) locations, despite their large physical floor space, seem to have less selection than department stores with smaller footprints?    

The average Costco location, according to equity analyst Zain Akbari, has less than 4,000 products to keep in stock. Meanwhile, at Walmart (WMT), we’re talking about 140,000 products that dilute the company’s purchasing power. Costco, on the other hand, can use its concentrated approach to bargain for the best value and private-label offerings with Kirkland (KIRK) that are hard to beat.

Investors in Costco should take comfort in the power of the brand and structure it has built, having just been through quite a few challenges in the last decade and a half. From a financial crisis to the emergence of digital retail to two meaningful fee increases for Costco members, the company has proven its lasting power with membership renewal rates still around 90%.

For an intensely competitive retail sector with no switching costs, it’s especially impressive that Costco has managed to carve out a wide moat. With strengths that come from simplicity – a low-frills environment and a warehouse/retail floor setup that minimizes internal distribution costs, it’s hard for other stores to cut further and compete on prices.

As digital sellers continue to expand, we see Costco as well-positioned for decades to come based on a membership model that makes up 55% of earnings. We also see fuel and food products driving traffic – and it’s hard to see Amazon offering cheap gas or hot dogs anytime soon.

For Morningstar, I’m Andrew Willis.

 

bulls Bulls Say

  • Costco’s membership format exhibits strong customer loyalty, with renewal rates holding steady around 90% in a variety of economic environments and despite Amazon’s growth (particularly Prime) and the broader digitization of retail.
  • Costco’s focused assortment reduces complexity while concentrating its buying power, which we believe grants the firm exceptional procurement leverage.
  • While inflation has affected consumer spending, Costco’s value orientation should be compelling.

bears Bears Say

  • The retail landscape is intensely competitive, with hard discounters and digital sellers exacting pressure on incumbents.
  • As digital retailers scale and build distribution leverage, they may eventually be able to offer comparable values to Costco’s offering.
  • We believe Costco’s international membership base is less durable than its American and Canadian counterparts, raising the bar for the firm over the years ahead as its domestic footprint reaches saturation.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Costco Wholesale Corp709.51 USD-0.24Rating
Kirkland's Inc1.92 USD-2.79
Walmart Inc59.53 USD0.46Rating

About Author

Andrew Willis  is Senior Editor for Morningstar Canada

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