Costco Remains the Wholesale King, but Is It an Ideal Investment?

By Anthony Shields  NOV 12, 2012 2:36 PM

Thinking about investing in Costco before the holidays? We have your fact sheet right here.

 


MINYANVILLE ORIGINAL Thanksgiving and Black Friday are fast approaching and consumer-based companies are bound to see an uplift in business in the coming days. In particular, the increase of grocery and consumer product sales are bound to favor the bottom line of Costco (NASDAQ:COST), which remains the leader in wholesale retail despite resisting the changes Amazon (NASDAQ:AMZN) has made to the industry. Still, the question must be asked: Is Costco a stock worthy of investment, or are its glory days soon coming to an end?
 
To really answer this question we must first dive into Costco’s strengths and weaknesses. The Motley Fool did a great SWOT analysis of Costco, but I’ll summarize their best points.
 
Strengths
Costco has over 67 million cardholders worldwide and the highest membership retention rate at a whopping 86% (90% in the US and Canada alone). Head to head, its prices are lower than its competitors and it has been getting solid revenue and membership growth year-to-year. The  company has a great reputation and a very strong brand, for reasons that include the quality of its store brand products, membership benefits that go from auto insurance to five-star vacations, and its now-famous free samples that greatly improve its consumers' shopping experience. It’s also worth noting that unlike Wal-Mart (NYSE:WMT) Costco’s employees are among some of the happiest around, as they receive some of the highest paychecks and best medical insurance, which is why the company has one of the lowest turnover rates in the industry.
 
Weaknesses
The major concern for Costco is that there are not enough warehouses to meet its demand. Costco has a relatively low urban presence, and most customers can consider themselves lucky if a trip to one of its warehouses doesn’t take up most of their day.  The company is much more exclusive than most stores, and doesn’t do enough to rake in new customers through ads and promotional events.
 
Opportunities
The good news is that Costco’s low presence in certain areas leads to great opportunities for future growth. The company has already achieved success in its efforts to expand worldwide, and will likely continue its efforts into the future. Also, adding an online membership option for a reduced price may greatly increase the company’s membership and ability to market itself, while also helping to curb Amazon as a major threat.
 
Threats
Costco has a lot to learn from Wal-Mart to Amazon to BJ’s and Target (NYSE:TGT), but few of these retailers deliver on price and customer experience in the same way as Costco. Wal-Mart is Costco’s most apparent threat, not only because of its locations and discounts, but also through its ownership of Sam’s Club, Costco’s No. 1 rival. Sam’s Club will also soon be carrying Apple (NASDAQ:AAPL) products, which could boost its sales in the future. Also alarming is the strong possibility that Amazon will soon sneak up on its compeititors and take even more of the wholesale market, especially now that its Prime service has been expanded and offers free shipping and handling to add to its low price and convenience.  
    
While the SWOT analysis makes Costco looks good, an article by Daily Finance revealed that Costco’s financial record falls short of standards in more than a few areas. Costco’s overall growth in the past five years has only been 9%, short of the 15% investors like to see, although its growth over the past year is only .5% behind the 12% standard. In terms of margins, Costco has only seen an increase of 12.4% increase in gross margins and a measly 1.5% increase in net margins. In terms of equity, the wholesaler only has a 12.5% debt-to-equity, and falls just short, by .9%, of the 15% return on equity that the website’s analysts like to see. Right now the current yield on dividends is only 1.1%, but over the past five years the stock dividend has grown 13.4%, indicating that things might get better in the future.
 
In the end, the analysis seems to indicate that Costco may hold onto its crown as the king of wholesale for quite a bit longer, but its financial numbers aren’t strong enough to see it as the perfect stock to have in your portfolio. If the company comes up with a way to directly deal with Amazon and increase its presence, it will no doubt ensure its profits going forward, but if not, investors would be right to worry.    
No positions in stocks mentioned.