Initial Report: Costco Wholesale Corporation (COST), 65% 5-yr Potential Upside (VIP SEA, You Gin CHENG)
Keeping up with Costco
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Company Description:
Costco Wholesale Corporation is the world's third-largest retailer. It engages in the operation of membership warehouses in the US and worldwide with 847 locations as of 2022 and 8 e-commerce websites globally. Costco offers branded and private-label products in a range of merchandise categories such as groceries, household items, etc. Costco differentiates itself from other retailers by operating a membership-based business model.
Highlights:
In 2022, Costco opened 26 new warehouses, 7 of which are outside the US and Canada.
Net sales increased 16% to $223 billion driven by a 14% increase in comparable sales and sales at new warehouses opened in 2021 and 2022. Membership fee revenue increased 9% to $4,224, driven by new member sign-ups, upgrades to Executive membership, and an increase in renewal rate.
Business Segments:
Merchandise Sales Volume:
Makes up more than 90% of the company’s revenue through sale of in store Stock Keeping Units (SKUs)
Membership Fees (2% of Net Sales):
Retailers have to be a member which comes at a cost (2 tiers) in order to access the bargain prices offered. Currently over 120 million members.
E-commerce Sales (7% of Net Sales):
Shipping merchandise through Costco's depots, logistics operations for big and bulky items, as well as through drop-ship and other delivery arrangements with suppliers.
Industry Overview:
Global retail sales was estimated to be $25.8 trillion in 2022 and is set to grow to $32 trillion in 2026 representing a CAGR of 5.53%. Traditional industry growth drivers include economic growth, franchising, and the availability of retail finance options. Post COVID-19, technology became the main driver, where e-commerce enables faster adaptation to market demand and cost reduction through streamlining supply-chain distribution.
Rising Costs
Retail inventories remain elevated, up 17% in the 12 month period between October 2021 to October 2022. High inventory supports warehouse pricing as there is less available space thereby increasing costs. There is also a mark-up of products by suppliers leading to higher input costs for retailers. Additionally, advertising expenditure is expected to increase at a CAGR of 11.4% over the next five years.
Investment Thesis:
Ability to retain superior market share and solidify its customer base
Costco’s membership model gives a high-margin and recurring source of revenue while also driving customer stickiness with worldwide renewal rate over 90%. Costco has generated strong revenue growth consistently with revenue increasing at a CAGR of 12.52% from 2018 to 2022 even through the pandemic.
Due to its size and purchasing concentration, Costco’s bargaining position is unparalleled.
Costco uses its bargain power to extract lower prices and demand higher quality from its suppliers and these work because what the suppliers lose on margin, they’ll regain in volume.
This translates to lower prices for members and helps to drive more memberships, thereby increasing sales for Costco and more leverage over suppliers.
Costco carries 4000 SKUs per store on average which gives it an advantage in terms of supply chain efficiency. This reduces complications which large retailers face and translates to better cost management.
Margins
Outward Expansion into the Global Market
Costco is poised to keep its long-term expansion going. Costco is set to open 23 new warehouses in 2023, 10 outside of the U.S. There will also be 6 stores in China by end 2023, which management sees as a meaningful international growth driver. Management also sees new warehouses in the 65/35 ratio US and Canada to international, moving to 50/50 over time. Growth in international warehouses being higher than the US and Canada.
Strong Financials to Support Further Growth
Costco has historically maintained strong liquidity and solvency ratios
Costco is less levered vs its peers given its lower debt-to-equity ratio. In a high interest rate environment, this puts the company in a more advantageous position to take on debt when needed.
Additionally, the company’s impressive interest coverage ratios indicate a strong ability for the company to pay for outstanding debt obligations, and its strong operating income levels provide a safety net given its increasing cash balance.
Costco is also able to reward shareholders handsomely through generating substantial profits.
Costco’s improving ROA displays the company’s increasing efficiency in utilizing its assets and managing its balance sheet to constantly generate profit
Costco has maintained consistent and resilient ROE growth as compared to the increased volatility
Valuation
Current Multiple is above the historical average but given its strong growth potential. There is potential for it to remain at 35-40x PE. EPS growth of 16.7% CAGR past 3 years. Assuming same forward P/E ratio of 38 and EPS of $15.33 (assuming same earnings growth), implied share price= $582.54 (11% Upside)
*Do note that all of this is for information only and should not be taken as investment advice. If you should choose to invest in any of the stocks, you do so at your own risk.