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Why the Club King Won't be Dethroned

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

Before investing in a company, it’s a good idea to get a sense of its overall picture.  A great way to accomplish this is with a SWOT analysis.  It examines a company’s strengths, weaknesses, opportunities, and threats, in a manner that makes it easy to gain perspective.  Once you’ve considered these factors, it’s easier to determine how the growth story factors into the equation. 

Let’s examine wholesale clubber Costco Wholesale (NASDAQ: COST) to better understand the big picture.

Strengths

  1. Wholesale leader.  Boasting over 67 million cardholders worldwide, Costco is the undisputed wholesale club champ.          
  2. Membership loyalty.  Costco knows how to make a customer for life.  In the US and Canada, they keep 90% of their members.  Worldwide, it’s 86%.  For businesses, it’s 93.7%. This last number is important because businesses and executive members account for two-thirds of sales.     
  3. No frills approach.  You won’t find fancy buildings, sales people, or big advertising budgets getting in the way of great values.  According to Costco’s Co-Founder, Jim Sinegal, “We run a tight operation with extremely low overhead which enables us to pass on dramatic savings to our members."
  4. Best value.  You have to work hard at beating Costco’s prices.  Even in a head-to-head showdown, Costco beat out rival Sam’s Club in cost per unit.              
  5. Tenured management.  Costco believes in a homegrown approach to management, which is why their current CEO has been with them for over twenty-eight years.         
  6. Big Growth.  Last quarter, EPS rose 28.7% on revenue growth of 14% from the previous year.  For the entire fiscal year, the average sales per warehouse were up 7% to $154 million.  Membership revenue grew 18%, mainly driven by fee increases implemented last November.  
  7. Organic food.  During the conference call the word “organic” came up three times associated with food.  It’s clearly a direction where Costco is headed in the future.  It’s a win-win for all parties involved.  Costco can make a higher margin by charging more for organic food, the restaurants who buy these items benefit from being able to charge a greater premium per plate, and the behind-the-scenes farmers are utilizing sustainable practices.            
  8. Private label.  Equal or better quality for a better price.  That’s the name of the game for Kirkland Signature, Costco’s private label.          
  9. Free samples.  How great are free food samples when you shop?          
  10. Happy employees.  Smiling employees are key to making Costco the best shopping experience.  Behind the smiles are higher paychecks, greater benefits, and one of the lowest employee turnover rates in the industry.  Costco takes care of their employees, which in turn take care of its members.  Also noteworthy, Costco doesn’t foresee a material impact under the Affordable Care Act because they already provide healthcare to all of their employees.           
  11. Great reputation.  With membership renewal rates as high as they are, it’s a no brainer that Costco is highly praised amongst members.   
  12. No hassles.  Costco prides itself on transparent return and satisfaction policies.  Follow the policy, and you won’t be hassled over a return.  If you aren’t 100% satisfied, members can return their membership for a full refund.      
  13. Great membership benefits.  From health and auto insurance to five star vacations, Costco offers more than just great warehouse prices.  They’ve formed strategic relationships with outside parties to ensure your membership goes further.            
  14. Fee hikes less than inflation.  Every five years, Costco tends to raise dues for membership.  Fee increases aren’t an easy pill to swallow, but it’s easier knowing that the increase is less than inflation.             

Weaknesses

  1. Not enough warehouses.  Warehouses are around, but they aren’t abundant.  They tend to be located in regions where many suburban areas converge.  If you don’t live nearby one of these areas, it becomes more a time consuming event to shop at Costco.        
  2. Outsiders don’t get it.  Have you ever talked to your non-Costco friends or family about how much you love Costco?  Maybe they’ve been to a warehouse a time or two, but the greatness isn’t registering.  And they think you’re crazy.                        
  3. No advertising.  When was the last time you saw a Costco advertisement?  They don’t exist.  Costco depends on word of mouth to get their message across.  It keeps their overhead low.  I’m starting to see a “Think Costco First” slogan inside warehouses, which may indicate we’re at the beginning of a grass roots advertising blitz.                  

Opportunities

  1. Untapped demand.  Because Costco has comparatively low retail saturation, there is tremendous potential for new business and membership growth.                      
  2. Future expansion.  Of the 612 locations worldwide, nearly three quarters are located in the US.  International expansion could fuel decades of future growth.  Next year, they plan on opening 27-30 new stores, half of which will be outside the US.   
  3. Private label growth.  As more stores open, more opportunities are created for Kirkland to compete against big brands.  You can also plan on seeing more margin enhancing Kirkland Signature products in the future. 
  4. E-commerce.  Costco.com is currently members only, but imagine if they offered a dot-com only membership to access all the savings?  These new members perhaps wouldn’t have the privilege of shopping in warehouses, but this approach could rapidly expand their market saturation.  It could lead to improved margins while simultaneously improving revenue growth.                     

Threats

  1. Wal-mart (NYSE: WMT) is public enemy number one and two.  That’s because the king of rollback is also the owner of Sam’s Club, Costco’s number one competitor.  Between the two brands, they make a formidable challenger.  Atop their agenda is taking Costco head on and turning Sam’s Club into a $100 billion business, which is right where Costco is today.  They are planning on launching new brands, more rebates, and fresher groceries to help lure Costco loyalists to the dark side. 

    But that’s not all Sam’s Club CEO Rosalind Brewer has in mind.  First, she plans on having clubs open earlier in the morning for same-day business customers.  You can also count on Sam’s more competitive membership fee to increase.  And Apple products will be in the mix, new stores will be opened, more self-checkout lines will promote more employees on the sales floor, more complimentary pharmaceutical services will be offered, and more frills.  At the end of the day, all these initiatives leave me wondering how prices will remain as competitive as Costco’s.            
        
  2. Amazon.com (NASDAQ: AMZN) has a much greater reach than Costco.  I’m fully expecting the king of smiley boxes to expand their private label brands, as well as further promote their Subscribe and Save consumer staple offerings.  It’s also entirely possible that Amazon Prime becomes a membership program for deeper discounts on goods.  All these efforts make Amazon a threat that can’t be left unattended. 

  3. Although BJ’s recently went private, they have quite the stronghold on the east coast with 190 stores across 15 states.  Their model is extremely similar model to Costco’s with a few differences. For one, all manufacturers’ coupons are accepted at BJ’s where Costco doesn’t accept any outside coupons.  The other difference is that all major credit cards are accepted at BJ’s.  Costco only accepts American Express.

    Costco has the lead in terms of economy of scale.  BJ’s retail footprint is 70% smaller and their last reported annual revenues were 90% less than Costco’s.  In other words, it’s near impossible for BJ’s to compete on price alone.  They try to make up for this shortfall with more convenient locations.  We’ll have to wait and see if BJ’s growth plans affect any of Costco’s future decisions.     
     
  4. Target (NYSE: TGT) has become more aggressive with their Low Price Promise.  For the holidays, they are willing to price match popular online sources, but exclude wholesale clubs.  This is the result of Amazon.com’s initiative to encourage users to price compare in-store items with a smartphone.  They hope this countermeasure mitigates the majority of the showrooming phenomenon they’ve encountered.    

    On a Costco to Target basis, they stack up to be very different companies.  In terms of revenue, Costco generates about 30% more revenue than Target, even though they have nearly the same market cap.  For every one warehouse Costco has, Target has 2.9 stores.  On a warehouse to store basis, Costco’s average revenue per store is $114.4 million more than Target’s $39.6 million.  In terms of values, Target is all about frills and fancy locations, which is a huge departure from Costco’s conservatism.                             

  5. In terms of size, Dollar General (NYSE: DG) may have the retail footprint, but they lack the revenue to back it.  Costco is a $99 billion a year business.  Compared to Dollar General’s $14.8 billion, it’s no contest.  Who do you think has the greater economy of scale?   

    With that being said, Dollar General has the location advantage over Costco, and they’ve been in the business a lot longer.  Their approach differs in that they aim to serve smaller neighborhoods that cannot support having a Wal-Mart.  When you boil it down, it’s a different demographic than Costco’s bread-and-butter business customers.                  

Bottom Line
The purpose of conducting a SWOT analysis is to gain perspective of a potential investment.  In the case of Costco, they’re a well-oiled machine that sticks primarily to their strengths.  New stores will prime future growth and Costco will continue to deliver the best in class wholesale club experience.  I’m confident about their future, provided they continue to execute exactly as they have been.  If they keep their priorities focused on great value, high quality, and no frills, Costco will remain the club champ.     

 


TopDownTrends has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com and Costco Wholesale. Motley Fool newsletter services recommend Amazon.com and 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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