EUR 850.00 For Business Accounts Only

Morningstar | Competitive Advantages, Steady Execution Should Keep Costco Strong in a Changing Retail Landscape

Although competition is intense throughout retail, we expect Costco's differentiated business model will keep its ability to generate outsize returns intact for the foreseeable future. Costco operates a warehouse club model, deriving about 70% of its operating income from membership fees and the rest from below-average markups on merchandise, including fuel. We estimate that in aggregate, the average markup on a Costco product is in the low teens (versus Walmart's roughly high 20s). Further, the firm generates high sales volume and rapid inventory turnover by selling roughly 3,700 fast-turning stock-keeping units--significantly fewer than the 60,000 its competitors sell--in bulk in a no-frills shopping environment. From our vantage point, the use of fresh food and gas as loss leaders should enable Costco to preserve its market share, withstanding competition from other discounters and online players like Amazon.Costco boasts over $1,200 in sales per square foot versus competitors at $600 or less. Its sales strength comes alongside efficiency. Costco reduces its supply chain drag time and cost by purchasing merchandise directly for shipment to its sales floors. Its self-serve format reduces back-of-warehouse needs while improving service levels, contributing to the model’s efficiency. Costco has become a one-stop shop for its 94 million loyal members, who can shop for general merchandise, groceries, fuel, and other items at its more than 760 clubs worldwide. Membership renewal and retention rates have been close to 90% globally, with the international markets slightly behind North America despite the firm's 10% increase in membership fees in the U.S. and Canada in 2017 (consistent with Costco’s historical performance following fee hikes). We believe the high renewal rates suggest Costco benefits from a strong brand that stands for high quality and low cost; combined with its exceptional productivity, this leads to strong returns on invested capital, most recently 18% in fiscal 2018, more than double our 7% cost of capital estimate. We expect the firm will continue to generate excess returns over the next 20 years.