Costco
Overview:
Costco is the third largest publicly owned retailer in the world. They are known for having the cheapest products available for sale while also selling them in bulk. They originally pitched their target markets as both the wholesale supplier for small businesses and a cheaper alternative for individuals. They focus on a limited range of high-volume goods and aim to be the market price leader for these items. The narrow range of goods allows for a streamlined inventory management system and the high volumes provide Costco with leverage over its suppliers. This has caused them to be widely popular among customers as they don’t have many other competitors that are able to provide the same value to their shoppers.
Thoughts:
Costco is a retail chain that every American has visited at least once. This puts them in a favorable position as it essentially means they are recession-proof. No matter what the economy looks like, there will always be shoppers there. In fact, I believe Costco has an advantage over even better-known brands such as Walmart due to their competitive pricing. As the spending power of customers decreases, there will be more and more shoppers at Costco which makes investing in them the safest bet out of almost any other retail chain. Additionally, Costco has an additional way of making revenue, even if their sales decrease. The only way to shop there is if you have a paid membership. This has created a massive cash flow for them with a 0% operational cost.
I see memberships being something that a customer would never cancel, no matter how little they shop. Once a membership is canceled, the person would never be able to shop there again unless they get another membership. Looking at the people who are likely to cancel their membership the most, they are most likely the ones who have been affected by inflation the most. However, I believe that this would just mean they will be shopping at Costco even more often than before instead of canceling their membership due to the low pricing Costco has to offer.
As stated by Morgan Housel, a financial analyst and author, every market valuation is a number from today multiplied by a story about tomorrow. The main story everybody has been talking about is the potential recession which has also had a big effect on stock prices. As I have also previously talked about this in the past, many investors are now closing their positions in other companies and investing them in safer stocks instead. I see Costco being one of the safe options. Even looking back at the pandemic when many companies were struggling, Costco not only wasn’t affected by it, but they were also consistently increasing their revenue. I believe it is going to be the same case again if a recession occurs. They will keep continuing to increase their revenue as there will be more customers than ever due to their pricing while other retailers will struggle.
The main trend that I have noticed this quarter is that investors don’t care about the future forecast anymore as long as the company doesn’t have any results to show. I have seen many companies providing a good forecast but their stock still ended up dropping as investors didn’t have any proof to rely on.
Additionally, considering that they always sell their products at very low prices, this leaves them with very little room to make a profit. After rapid price increases, along with low-profit margins, their revenue can decrease very quickly which will also cause their stock to drop.
Another disadvantage that I find is that Costco is the first stock to come out with a report this quarter in the grocery chain sector. As investors still don’t know what to expect, expectations could be set quite high which will be hard to beat. At the same time, I believe that most investors are still holding their shares as they are waiting for the report to make their opinion. Considering that this is the first grocery company to come out with a report, most people would want to see what the future may look like first, and even with the slightest bad news, there could be a sell-off. This news will particularly look bad as nobody else has announced it yet and many people could think that it’s only related to Costco.
Disadvantages:
As seen by the chart above, there has been a decrease in both their revenue and memberships. I’m expecting this trend to continue and for Costco to lose even more memberships this quarter. Considering that these memberships are one of their main sources of revenue, a decrease in it will be a great disappointment to investors. The growth in sales leads to the same growth in costs associated, and due to their low pricing, most of their profit comes from the Membership Fees segment. This segment has grown by 9% in the last couple of years and the growth largely depends on signing up new customers rather than increasing membership fees as they have not increased the basic $60 yearly fee since 2017. I believe this type of consistent growth is going to be over for two main reasons.
Many people believe that due to inflation, there are going to be more shoppers going to Costco and therefore there is going to be an increase in their membership subscriptions. However, this is a problem that consumers have been dealing with for around 8 months now. At the same time, their spending power has increased much more compared to last year due to the extra jobs that people are getting. What I believe is that during this period, most people have already gotten their memberships instead of waiting for almost a year. Many people confuse customers shopping more often with a higher number of memberships when reality, most of these customers have already had their memberships from the past.
The second reason why I believe their memberships are going to decrease is due to the massive surge that happened during Covid. As also seen in the graph above, there was a massive increase from 2020-2021. In my opinion main reason behind this surge wasn’t due to their lower price. During the pandemic, people wanted to come out of their homes as little as possible so they stocked up on different types of products. Considering that Costco sells most of their products in bulk, specially at lower prices, many people decided to shop there instead. As this period has now come to an end, I believe their membership numbers will go down to around what it was in 2019.
As also seen in the picture above, Costco has the lowest retail markups over any of its other competitors. While this might be considered a good thing by some investors, I disagree. This also means that they have the least profit on each item sold compared to everybody else which isn’t a good look in the current environment. Additionally, a price increase will also be looked upon as negative considering that their business strategy is to sell as cheaply as possible. This increase in price will force many customers away from their brand which would lead them to lose even more money.
Costco's net income likely increased by 10% on a year-over-year basis, however, the company is expected to report comparable sales growth declined for the seventh straight quarter. Despite January's unexpected surge in U.S. retail sales, Amazon, Walmart, and Home Depot all have warned of slowing consumer demand.
Retail giant Costco likely will report its weakest sales growth in more than three years when it reports its fiscal second-quarter results
Meanwhile, along with other retailers, Costco's expenses have risen. Its quarterly merchandise costs are expected to rise 6.8% compared with a year ago, according to Visible Alpha, reducing its gross profit margin slightly to 12.1%.
Over the last 3 months, EPS estimates have seen 5 upward revisions and 9 downward. Revenue estimates have seen 2 upward revisions and 16 downward.
Taking a look at a graph that breaks down their revenue, it can be seen that most of it has been coming from America. I see this as a big problem as if there is a recession, most of their revenue is going to get wiped out. Many people considering investing in Costco due to the diverse locations they have around the world, however, USA stays the only country they are dominant in and rely on.
Advantages:
As seen by the chart above, revenues have been growing at over 8% compounding for the last 10 years with an even faster rate over the last 5 years. They were also not noticeably impacted by COVID. Unlike many other retailers, operating margins have been increasing every year for more than 10 years. These consistent results, even in unforeseen circumstances, make Costco a great pick for an investment considering the recession we are heading in
As shown above there has been a consistent increase in their EPS throughout the years which shows their strong business fundamentals. While it can’t be 100% proven, looking back at their results, also shows their ability to do well in a recession. This gives both new investors confidence to invest and also existing investors to keep their positions open. The reason why I find this EPS increase important is that it shows their profitability. Even with small profit margins and high operation costs, they are still able to increase their revenue.
Walmart VS. Costco
While they both might look similar on paper, I find these two companies to be nothing alike. Looking at Costco, it’s the type of store you go to when you go monthly shopping for different types of products that you might need to stock up your shelves with. Walmart on the other hand, customers go to for their daily needs and grocery shopping. So a person who might go to Walmart every day visits Costco only a few times a month, even if they are a customer of both brands. Walmart’s low-profit margin can be justified by these daily shoppers, however with Costco, their customers visit them much less often. This will still be true even during a recession as people need to go grocery shopping no matter what, however, Costco on the other hand, is mostly used for unnecessary snacks and products that aren’t needed in your day-to-day lives.
Another thing to have in mind would be seeing where a customer would go in case of a recession. As I explained earlier, I believe during the pandemic they didn’t raise their revenue because of their strategies or business plans, but because customers wanted to leave their homes as little as possible. However, it won’t be the same for this recession. When considering a person who has a low budget, you would never imagine them buying something in bulk so that they spend less on each product they buy, what you would imagine is only buying one or two of that specific item. Target and Walmart would be the perfect option for that and considering how Costco is known for its bulk item selling policy, customers won’t even think of visiting the store.
Investor sentiment:
“Great companies are seldom cheap. My only monthly attempt at buying COST is the sale of puts with strikes around 400. I never get put but the premiums cover my Costco purchases.”
“COST is in a valuation bubble. You can only defy the laws of gravity for so long. Maybe it continues, maybe not. Fed will keep raising. I am the voice of reason Saying COST LT 20yr PE is 26.5x and it trades at 36x PE today. That's 35% premium to historic levels. I sold all my shares at $515. That's why the markets are obsessively hanging on to everything the FED does and says now, because the markets are completely reliant on this easy money policy. Doesn't take a lot of smarts to figure out what happens if they keep raising or just keep rates where they are.”
“Costco is too expensive and is the only thing I have heard for ten years. Go search for articles in 2010. They all recommended Sears! Over Costco. Thank god I still bought it.”
SWOT Analysis:
Strengths:
Very cheap pricing
Loyal customers
Have an edge over competitors
No debt
A very strong management team
Weaknesses:
Low profit margins
The only way to shop is if you have a membership
Most of their revenue relies on their American chains
A weak future outlook expected
Opportunities:
Advertise more
Expand their locations so that they have more revenue sources except the USA
Have different types of membership tiers for people who can’t afford the full price
Sell a wider variety of products
Threats:
One of the first to come out with a report this quarter
A weak forecast
Low profit margins with high operational costs
Possibility of customers canceling their memberships
High reliance on memberships rather than product sales
Competition:
Walmart so far has been the only big grocery chain to come out with a report this quarter. The future forecast that they predicted was very weak which resulted in a price drop. Most investors are also expecting Costco to confirm the bad outlook. Additionally, most of the retail chains have also dropped in value over the past month, even before Walmart predicted a bad outlook. This shows me that investors don’t see grocery chains as stocks that they can trust during a recession.
Costco’s Moat:
The sources of strength in Costco’s moat mainly come from:
An excellent brand that is well respected by its customer base
the relatively lower operating cost model it has created through the strategic criteria used to determine the product range, the configuration of its warehouses, and the layout of its stores
The much lower product prices compared to other retailers
My overall thought:
Although I had originally wanted long this company, after further research, I believe shorting it would be a better idea. What I realized is that investors aren’t just looking for a stock that won’t drop during a recession, but also a stock that will keep increasing in value, no matter the environment. Although grocery chains won’t lose their value, they also keep breaking revenue estimates in case there is a recession which results in stagnancy.
Looking at the market conditions ahead as also pointed out by Walmart, I don’t see any reasons why anybody will hold this stock. Even if they beat all the estimates and come out with a great report, there still won’t be any room left for improvements which is going to result in a valuation drop. Considering that Costco is also one of the first grocery chains to come out with their report, investors are extra cautious of any bad results, making the movement much more sensitive.
Estimate:
I’m expecting a 4% decrease after the report. As I also mentioned earlier, investors are going to be extra sensitive so any bad news could result in a price drop. At the same time, many investors who are new to investing could be waiting to see how others are going to react and once the market opens in the negatives, they will also sell their shares which will result in a bigger price drop. Additionally, the average movement after a report release has been 3% for Costco so this decrease is justified.
Time: Thursday after market close
Estimate: -4%
P/E Ratio: 36.18
Market Cap: 212,399,777,662