More Than a Warehouse Club
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Most people have many choices when it comes to their weekly or bi-weekly shopping trip for necessities around the house. For my household it usually means a trip to a local Target (NYSE: TGT), Wal-Mart (NYSE: WMT), or the privately owned Wegmans grocery store. What we don't currently have is, a warehouse membership although there is a local BJ's Wholesale in our area. The main reason we don't belong to BJ's is, we found it hard to avoid spending hundreds of dollars on every trip to the store. This is exactly the problem that makes a company like Costco (NASDAQ: COST) so successful.
Most investors are aware that Costco is a highly successful and profitable warehouse club. The company operates about 602 warehouses, and has just scratched the surface of its international potential. Costco is taking a slow and steady approach to expansion, expecting to add about 6 new stores by September 2012. The company has already posted to its web site that they have 7 additional locations planned for the following quarter. If the company continues to open stores at this pace, we are looking at an indicated annual run rate of about 4% new store growth. Where the company shines is getting more shoppers into its existing stores. In the most recent quarter, while revenues were up 8%, comparable sales were up 5%. Just as point of comparison, I've been a big fan of Target both as a shopper and as an investment for a while. However, Target just can't match Costco's efficiency when it comes to increasing EPS. In the most recent quarter Costco increased revenues by 8% and turned this into a 20% increase in EPS. Target by comparison, increased reveues by 5.9%, but only increased EPS by 5%. Both companies bought back shares, saw revenue growth, and same-store sales growth, but only Costco was able to turn this into double-digit EPS growth. While Target has no membership fees and Costco does, these fees seem pretty reasonable considering the savings available.
Members get a choice of a $55 “Gold Star Membership” which gives them access to all of Costco's deals. With most families taking a trip to the grocery store about once a week, the average household only has to save about $1.10 each week to justify this $55 annual cost. Even more favorable, would seem to be the “Executive Membership” at $110 a year. The difference is while the Executive membership is double the standard price, the customer gets a 2% reward each year. For a family spending say $600 a month on grocery and related items, this 2% equates to about $144. This 2% reward would more than pay for the annual membership fee. While other warehouse stores offer cheap groceries, these membership fees get customers much more than just your standard warehouse club.
If you want to be amazed, click on “Services,” and marvel at the number of services that Costco members get special pricing on. The company offers discounts to its members that you just don't associate with a warehouse club. Just as an example, did you know that Costco can help you buy a vehicle? According to the company, “In the last 12 months, nearly 500,000 members turned to the Costco Auto Program to help them purchase their vehicle, boat, or RV.” Try going into your local Target and ask them about help buying a car, you'll likely get a blank stare. If the company doesn't offer the service directly, they have partnered with another company. If you need Auto & Home Insurance you're directed to a sales page for “Costco Insurance Agency” that offers Ameriprise as the insurance provider. If you want to use Intuit for payroll, you get “Costco exclusive prices.” My personal favorite is, if you want to invest, you can use one of my favorite brokers Sharebuilder. Costco members get a 30% to 50% discount off traditional rates. This benefit alone could pay for your Costco membership by itself. Try asking your standard Wal-Mart employee about discounts off brokerage fees, you might get kicked out. As you can see, membership gets you a lot more than just cheaper groceries.
These additional savings and services are great, but in order for Costco to continue its growth, the company will need to grow its warehouses. With just 167 stores outside of the U.S., the company can grow for decades without getting close to saturation. For a point of comparison, Wal-Mart operates over 4,000 locations internationally of which about 165 are Sam's Club stores. While Sam's Club stores are Costco's more direct competitor, Wal-Mart has chosen to build its network around the traditional Wal-Mart brand instead of the Sam's Club brand. Most people think of Costco stores as larger than Wal-Mart stores, but that is actually not true. The average size of a Wal-Mart store is 108,000 sq. ft., and a Supercenter can be up to 185,000 sq. ft. Costco stores by comparison average 143,000 sq. ft. You can see that based on the size of a store, wherever a Wal-Mart can be placed, its a pretty good bet that Costco could go there as well. The only difference between a shopper buying at Costco versus buying at Wal-Mart is the memberhsip fee. Costco carries larger sized items which allows customers to save money overall. Wal-Mart carries standard sized items at everyday low prices. International shoppers seem to like their experience at Costco enough to come back and buy more. In the most recent quarter, international same store sales growth came in at 8% versus U.S. sales came in at 4%. With the potential for thousands of warehouse clubs outside the U.S., as this division becomes a bigger part of the whole, Costco's growth could pick up.
In short, Costco is a growing warehouse club that offers much more than a standard club store. Motley Fool CAPS members are bullish on Costco too, rating the company a perfect five out of five stars. Target and Wal-Mart are more well known companies, and have more stores, but rate four stars each. Those who are bullish on CAPS, mentioned multiple times “buy what you know.” I guess if you are a loyal, satisfied, Costco member, it's pretty easy to understand why the stock should do well. At nearly 24 times forward earnings, the stock isn't as cheap as other big box retailers, but the company's over 13% expected growth rate helps to offset that a bit. The 1.1% dividend, that only uses 20% of free cash flow, helps explain part of the company's valuation as well. With a sticky customer base, huge international expansion opportunities, and services that offer additional growth opportunities, Costco seems like a solid long-term buy.
MHenage 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.If you have questions about this post or the Fool’s blog network, click here for information.