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Morningstar | Costco’s Value Proposition Should Endure Despite Broader Retail Turmoil

With a besotted membership base, low-frills warehouse shopping experience, and growth opportunities at home and abroad, we expect Costco’s durable competitive advantages to lead to consistent, strong performance despite the upheaval in retail. Although the competitive environment is intense and becoming more challenging as Amazon scales and physical rivals deliver an omnichannel experience, we believe the values that Costco offers (driven by cost leverage, procurement strength, and sector-leading store efficiency) should allow it to keep traffic high. With what we see as ample opportunity to expand in the U.S. and in existing and new international markets, we expect Costco to post consistently strong returns even as it grows.Through a financial crisis, the maturation of digital general merchandise retail, the expansion of Amazon’s Prime offering, a credit card provider switch, a robust current economy, and two meaningful fee increases, Costco’s membership renewal rates in the United States and Canada have remained at roughly 90%. We suspect that the traffic-driving values that Costco offers in its stores (often enabled by requiring large-quantity bulk purchases) is fueled by cost leverage and procurement strength that, in turn, feeds additional store visits.Despite its warehouses’ large size (roughly 145,000 square feet), Costco concentrates its buying power on a small number of items, featuring roughly 3,700 stock-keeping units versus about 75,000 to 80,000 at Target or what we estimate as about 140,000 at Walmart supercenters. This creates outsize purchasing leverage that we believe is a key ingredient in delivering the values Costco offers, augmented by a robust private-label offering.We believe the firm’s food and fuel offerings drive traffic and suspect that Costco is poised to thrive even as digital sellers expand. Although we expect it to keep pace with rivals by further developing its omnichannel offering (roughly 4% of fiscal 2018 sales came from e-commerce, in line with Walmart’s namesake U.S. stores and its more direct rival Sam’s Club), we believe that Costco’s value proposition should support continued member growth and in-store sales expansion.