One-Stop Shops Costco and Wal-Mart Will Be Ascendant for Years

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

The internet may be chipping away at most retailers, but there are some big box retailers will not vanish. They will be sources of goods that are convenient to pick up locally, or time-sensitive but hard to find elsewhere.

Costco (NASDAQ: COST) and Wal-Mart (NYSE: WMT) are two stores that are becoming more and more important. At least that is my perception from living in the country. It might be different in other parts of the US, but Costco is where you go for food with a long shelf life and big ticket appliances. Wal-Mart is where you go if you want items you just do not need in bulk, but would be pointless to order online. The scope of these stores far extends my uses of them, but I hardly think I am representative of the population.

Costco's fundamentals are pretty good, but a margin below 2% bothers me. In general, paper thin margins make me uneasy, because there is a lack of cushion. Fixed costs do not decline nearly as fast as revenue when bad things happen. Companies with a healthy margin can absorb that decline while making changes. Paper thin margins mean that companies get hit hard while they make changes. Costco has a paid membership aspect, so I would think that would provide a nice boost to margins; but upon further consideration membership dues are very reasonable, and probably pale in comparison to sales. Margin is in line with history, and therefore is not a red flag. However, I will keep an eye on Costco for improving margins because that would be an exceptional sign.

Costco has low debt, with the debt to equity ratio at 0.1104. I like that because I think Costco needs to expand into other countries. If Indian politics can work themselves out to produce something even moderately beneficial, Costco would fit well there. I know the politics and economics get sticky, but I am not a mercantilist. I just think Costco is a great place with high quality goods and some very cheap gas. It also has almost $5 billion in cash, which is nice and comfortable in my opinion. Costco's revenue has been increasing every year, and it has been ramping it up even with the rough economy. That really impresses me, and I think margin could improve if it really made an effort. I do not know when or if margin will improve, but revenues have been going up consistently.

I think Costco could be a long-term winner, as long as there is intelligent expansion and cost control. I read the recent earnings transcript, but it was mostly numbers that are reflected in the financial metrics. I did not see much in the way of grand strategy, but some of the explanations were interesting. If you are not familiar with foreign exchange issues it might be a good read before you delve into that research. Of note was its floor space expansion metric. Costco is all about the size of the store and what is on display. More floor space usually means more stores, and this last quarter had some of the highest growth in recent history at a 5% expansion of square footage.

Wal-Mart just drives me a bit nuts conceptually. It has almost $500 billion in revenue for the trailing twelve months, which means that the company takes in half a trillion dollars. This is not profit, but on a conceptual level it is just staggering at how much money flows through Wal-Mart. Wal-Mart also sports a better profit margin than Costco, with 3.51% as the last quarter's margin. There have been instances where that number has risen to above 4%, and seeing this consistently would be a great sign. Half a percentage point is pretty good considering the amount of revenue.

Wal-Mart also boasts solid revenue growth. Maybe it will consistently break half a trillion in revenue very soon. I focus on revenue for both companies because it allows me to take in the scale of these businesses. If margins were volatile I would just look at net income ttm. No earnings call to read yet, but when it comes I hope management goes over more grand strategy than Costco.

Both retailers show impressive revenue growth, and I know both are looking overseas for expansion possibilities. The Costco earnings call discusses Mexican operations a bit. One big takeaway was that Costco completed acquisition of the other half of its operations in Mexico. That means any future expansion will go to the company completely. I am sure Wal-Mart is being just as aggressive about getting into new markets.

Both companies strike me as great investments, but I am not sure which one I would choose if I had to pick one. Under threat of bodily harm, I think Costco has more of a debt cushion to use in the case of expansion to capture new opportunities. That is a shaky reason to choose one over the other, because Wal-Mart is the larger company and can still muster a vast amount of leverage. But I tend to favor smaller companies, because I think those companies can make strategic decisions that have a larger impact on the stock. However, that is just a personal preference and a slightly riskier path.


TheArchivist 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.

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