Will This Company Be a Drag on Your Portfolio?

Himanshu is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The philosophy of “economies of scale” is very important in the prevailing economic conditions. This is mainly because of restrained spending habits of consumers. This philosophy is followed to the T by the warehouse retailer Costco Wholesale (NASDAQ: COST), which is making the most of it.

The retailer has been largely benefiting from its bulk purchase policy as it passes on the benefits to its customers. This lures customers in hordes leading to increased gains. Hence, Costco has been posting blockbuster quarters for quite some time now and its recent first quarter results were no exception.

The Benefits of the Policy Followed…

With an annual membership charge, people get the best deals for their daily requirements. In an economic environment where people are highly budget conscious, Costco’s discounts for bulk purchases make a lot of difference. This drives customer galore to the retailer’s stores. Its comparatively lower prices for gasoline are also attractive.

Moreover, Costco benefits from having fixed membership revenue, which acts like a cushion in times of crisis even if it comes at a price of thinner margins. Moreover, membership fees form a major chunk of the company’s top line.

Costco Wholesale has placed its business model well as it buys goods from the manufacturers, which comes in cheap, and sells it at lower margins. This makes its products highly competitive and customers do not mind buying in bulk since it weighs lighter on their wallets.

In fact, Costco had increased its membership fees since cost inflation was eating away its profits. And surprisingly, consumers were still equally excited to visit its stores. This makes it very different for its competitors, such as Wal-Mart (NYSE: WMT), to compete. Wal-Mart’s Sam’s Club also runs on a similar concept of warehouse retailing. In fact, its membership fee is lower than that of Costco Wholesale. Also, it allows its membership card to be used by anyone whether or not they are the actual owner of the card. This makes it easy for consumers. However, Costco does not provide for the same.

Competition Gets Tougher

Costco also faces stiff competition from dollar stores such as Dollar General (NYSE: DG). Dollar General offers extremely low prices, which attracts more and more customers. Dollar stores have been performing really well with stellar numbers posted each quarter. In fact, recently Dollar General reported its third quarter results were ahead of market expectations. Dollar General’s low priced products coupled with heavy promotions led to a 10% surge in revenue with a rapid increase in consumer traffic.

On The Go…

However, Costco has also been trying to make its position stronger. It has been making efforts to strengthen its online operations from quite some time. It is witnessing great growth in the segment and foresees greater success in future.

The wholesale retailer has also been on an expansion spree. International expansion has been in its cards and it plans to open a new store in the next one month. Additionally, it plans to add 30 new stores in the next year making its prospects brighter.

Conclusive Thoughts

The company has been faring well mainly because of restrained spending habits of customers. Also, membership fees have been the key driver of its performance. However, lower fees at its competitors’ stores might prove to be a threat. Also, growing importance of dollar stores have been a matter of concern.

Looking at the brighter side, Costco has been strategizing well with a lot of stress on its e-commerce business and geographical expansion. It has also declared a special dividend last month. These positive factors might help the company to fight competition better. But it is a little difficult to get a clear picture at this juncture. Hence, staying on the sidelines and watching the retailer’s moves carefully will be a prudent decision.

justhimanshu has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale. Motley Fool newsletter services recommend Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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