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WIKI ANALYSIS
Costco (NASDAQ: COST) sells food and general merchandise, including appliances and other household goods, in bulk and at heavily discounted prices. It operates 527 membership warehouses, 80% of which are located in the United States.[1] Costco's two main competitors are Sam's Club and BJ's Wholesale Club (BJ), both of which have similar business strategies to Costco. The company earned $69.9 billion in revenue in 2009, a 1.5% decrease from a year earlier.[2] This decline in growth was driven by a 4% decrease in comparable store sales and higher costs.[3]
Costco's low prices help the retailer maintain positive growth during rough economic times. For example, in Q4 2009, Costco's sales decreased 3.2% with a 5% decline comparable store sales.[4]
Costco's biggest concern is over expansion and cannibalization of existing store locations, which the company claims was part of the negative comparable store sales growth in 2009.[3] As a result, the company has announced it will slow its domestic expansion plans, opening 7 domestic stores in 2010, down from a peak of 25 new domestic stores in 2005.[1] Costco will instead look to international markets for future growth -- in 2009 the company opened its first store in Australia and opened several new stores in already existing markets in Taiwan, Korea, Japan, UK, and Canada. However in 2010, the company does not plan to open any new stores outside the US.[1]
Company Overview
Costco operates 527 locations stores of its membership-only warehouse club[1] that sell general merchandise including fresh and packaged foods, appliances, and apparel. Slightly more than 80% of the company's stores are in the U.S., with additional stores in Canada, Korea, Japan, Taiwan, and the United Kingdom.[1] The United States also accounted for almost 79% of the company's sales, followed by Canada at 14% and other international sales representing 7% of its 2008 revenue.[5]
The company focuses on selling high volumes of its merchandise at low prices at its warehouses worldwide, which together earned $71 billion in revenue in 2009.[2] This represents a 1.5% decrease in sales from 2008, which the company attributes to an 4% increase in comparable store sales and the opening of 24 new warehouses during 2008.[3] In 2010, Costco plans to open 7 net new stores all in the US.[1]
Business Segments
Costco's merchandise categories include:[6]
- Sundries (23% of 2009 Net Sales): Sundries is Costco's largest segment by revenue and includes the sales of candy, snack foods, tobacco, alcoholic and nonalcoholic beverages, and cleaning and institutional supplies. In 2009, sundries represented 23% of net sales, which was a 1% increase from 22% of net sales in 2008.
- Hardlines (19% of 2009 Net Sales): The hardlines segment sells major appliances, electronics, health and beauty aids, hardware, office supplies, garden and patio, sporting goods, furniture, and automotive supplies. In 2009 and 2008, this segment represented 19% of net sales.
- Food (21% of 2009 Net Sales): This segment is responsible for the sale of dry and institutionally packaged foods (oatmeal, rice, cereal, etc.) The food segment is Costco's second larget segment and in 2009 represented 21% of net sales, which was a 1% increase from 2008.
- Softlines (10% of 2009 Net Sales): Softlines is Costco's smallest business segment and is responsible for the sale of apparel, domestics, jewelry, housewares, media, home furnishings, cameras, and small appliances (toasters, microwaves). In 2009 the segment only represented 10% of net sales, which was the same as in 2008.
- Fresh Food (12% of 2009 Net Sales): The fresh food segment is responsible for the sale of meat, bakery goods, deli and produce. It represented 12% of net sales in 2009 and in 2008.
- Ancillary and Other (15% of 2009 Net Sales): The ancillary and other business segment is in charge of the company's gas stations, pharmacy, food court, optical, one-hour photo, hearing aid, and travel products. From 2008 to 2009, Costco has heavily increased the number of ancillary businesses including the addition of 16 gas stations, 15 food courts and hot dog stands, and 13 pharmacies. However due to the economic downturn and lower gas prices compared to levels in 2008, net sales of the segment decreased 2% in 2009 to 15% of net sales.
Business Growth
FY 2009 (ended August 30, 2009)[2]
- Costco's net income fell to $1.09 billion in 2009, a 15.3% decrease from 2008 due to a decrease in net sales and higher SG&A costs.
- Costco earned $71.4 billion in net sales, a 1.5% decrease from 2008. This was the first time that the company faced negative sales growth since 2004. The decrease in sales can be attributed to the economic downturn.
- Operating margin fell to 2.5%, down from 2.7% in 2008, which was mainly due to higher SG&A costs.
- Costco operated at a 10.81% gross margin, up slightly from 10.53% in 2008 due to 0.24% increase in sales higher margin categories, primarily food and sundries.[7]
- Comparable store sales decreased by 4% in 2009 compared to an 8% increase in 2008. The decrease in comparable store sales were primarily due to lower average amounts spent by consumers as well as lower gas prices -- average sales price per gallon fell by 30% during the year.
- The company reduced its domestic expansion plans, opening 8 domestic stores in 2009 and 7 planned openings in 2009, down from its peak of 25 new domestic stores in 2005.[1] Similar to its main competitor Wal-Mart, Costco is also vulnerable to cannibalization from existing stores because of overexpansion. For example, Costco attributes cannibalization to its slowing growth in comparable store sales since 2005. Costco's domestic comparable store sales have increased an average of 5% annually from 2005 to 2009, down from 9% in 2004.
- U.S. sales decreased 0.6%, revenue from Canadian operations fell 7.5%, and Costco's other international sales increased by 1.7%.[5] This growth was primarily driven by a 6% and 15% increase in domestic and international comparable store sales each respectively
| Metric | FY2009 | % Change (or % Point Change) | FY2008 | % Change (or % Point Change) | FY2007 |
|---|---|---|---|---|---|
| Net Sales Revenue | $71,422 | -1.5% | $72,483 | 12.6% | $64,400 |
| Gross Profit | $9,087 | 1.2% | $8,980 | 13.0% | $7,950 |
| Operating Margin | 2.5% | -0.2% | 2.7% | 0.2% | 2.5% |
| Net Income | $1,086 | -15.3% | $1,282 | 18.5% | $1,082 |
| Comparable Store Sales | -4% | -12% | 8% | 2% | 6% |
Q1 2010 (ended November 22, 2009)[8]
- Costco's net income increased 1.1% year-over-year, from $263 million in Q1 2009 to $266 million in Q1 2010 due despite recessionary pressures from the economic downturn.
- Net sales was $17.3 billion for the quarter, up 5.5% from a year ago. The increase in net sales was attributed to a 3% increase in comparable store sales, which accounted for $535 million, and 21 net new warehouses, which accounted for most of the rest. Foreign exchange rates positively impacted net sales by about $203 million. Increases in net sales were offset by gasoline price deflation, due to a 11% decline in average sales price per gallon, which accounted for a loss of $160 million.
- Comparable store sales increased by 3% for Q1 2010. Same-store sales were positively impacted by increased shopping frequency but was offset by a decrease in the average amount spent. The company reported international same store sales growth of 10%, versus same store sales growth of 1% in the U.S.
- Operating profit for Q1 2010 was $434 million, and operating margin was 2.5% of net sales. This is a 10 bps decrease from Q1 2009, during which operating profit was $422 million, or 2.6% of net sales.
- The total number of cardholders increased to 56 million from 54 million a year ago.
| Metric | 3Mon ended Q4 FY2009 | % Change (or % Point Change) | 3Mon ended Q4 FY2008 |
|---|---|---|---|
| Total Revenue | $17,299 | 5.5% | $16,395 |
| Gross Profit | $2,218 | 4.7% | $2,119 |
| Operating Margin | 2.5% | -0.1% | 2.6% |
| Net Income | $266 | 1.1% | $263 |
| Comparable Store Sales | 3% | 2% | 1% |
Trends and Forces
Overexpansion Leads to Cannibalization of Sales
Costco's domestic comparable store sales have increased an average of 6% annually between 2005 and 2009, down from 9% in 2004.[2] Like most retailers, Costco's long term sales and net income growth depends primarily on opening new stores and expansion into new markets. However, Costco's overexpansion domestically risks cannibalizing the sales of preexisting stores, essentially competing with itself. For example, if Costco builds a store relatively close to one if its already existing stores, the new store might take away customers from the old store (a reason could be convenience) thus hampering comparable store sales -- this is cannibalization.
As a result of domestic overexpansion, Costco reduced its expansion plans since 2008 and switched focus to opening new stores in new markets internationally. For example, Costco opened 15 new stores in 2009, compared to its 2007 of 35 new stores.[9] Furthermore, in 2009 the company opened a new store in Australia and an additional 6 stores in new international markets.[10] However, due to the economic downturn and consecutive quarters of decreasing sales, the company does not plan to expand internationally in 2010.
Higher Employee Pay Leads to Better Performance
Costco's employees are paid significantly more than its competitors. For example, Costco employees are paid an average of $16 per hour, while Wal-Mart employees earn an average $9.68/hr.[11] Costco is also known for providing its employees with better benefits- Costco covers almost 90% of its employees health insurance premiums, compared to 60% coverage at Wal-Mart.[12] These higher labor expenses contribute to Costco's 2.77% operating margin[2], which is lower than Wal-Mart's Sam's Club operating margin of 3.65%.[13]
The upside to Costco’s high employee costs is increased productivity - in 2005, Costco earned $13,647 in operating profit per hourly employee, compared to $11,039 per employee at Wal-Mart.[11] Additionally, Costco has a lower employee turnover than the competition, which saves them money on employee recruiting and training costs. For example, Costco's employee turnover rate is slightly above 20%, significantly less than the industry average of 65% or Wal-Mart's 50% turnover rate.[11] According to a 2005 Rutgers University Study, Costco's lower turnover rate saves the company between $1.5 to $2 million in hiring and training costs each year.[11]
Low Prices Attract Customers During Weakened Economy
Because of its low prices and bulk product offerings, Costco is an ideal place for customers to stretch their dollars in times of an economic downturn. For example, the subprime lending crisis and 2007 Credit Crunch drastically reduced the levels of dispensable income for many consumers. In Q4 2008, Costco's sales grew by 13%, driven primarily by a 9% increase in comparable store sales as consumers gravitated towards Costco's low prices in the weakened U.S. economy.[14] However, just because the company sells items at low prices doesn't make it immune the the effects of economic recessions. In FY2009, the company's net sales decreased by 1.5% and net income decreased by 15.3%.[2]
Competition
Costco is the largest retailer in the warehouse club market in terms of sales.[2] Costco's main competition is Wal-Mart's Sam's Club. BJ's, a smaller retail warehouse chain, also competes with Costco and Sam's Club. The three companies share a similar business model, selling high volumes of merhandise at low prices in a membership-only warehouse club. Each company sells a similar array of general merchandise, including food, apparel, and gasoline.
- Sam's Club operated 602 warehouse clubs nationwide and earned $46.8 billion in revenue in 2008.[13]
- BJ's operated 180 warehouse clubs across the eastern U.S.[15] In 2008, the company received $10.0 billion in total revenues.
| Company | Revenue | Net Income | Operating Margin | Comparable Store Sales | Number of Store Locations |
| Costco | $71.4 | $1.09 | 2.5% | -4% | 527 |
| Sam's Club (FY 2008) | $46.8 | N/A | 3.4% | 4.8% | 602 |
| BJ's Wholesale Club (BJ) (FY 2008) | $10.0 | $2.3 | 2.3% | 9.4% | 180 |
References
- ↑ 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 COST 2009 10-K, pg. 16
- ↑ 2.0 2.1 2.2 2.3 2.4 2.5 2.6 2.7 COST 2009 10-K, pg. 19
- ↑ 3.0 3.1 3.2 COST 2009 10-K pg. 22
- ↑ COST Q4 2009 Report
- ↑ 5.0 5.1 COST 2009 10-K, Pg. 87
- ↑ 6.0 6.1 COST 2009 10-K, Pg. 4
- ↑ COST 2009 10-K, Pg. 23
- ↑ 8.0 8.1 COST Q1 2010 Report
- ↑ MSN Money 2/16/2007
- ↑ "Costco plans Australian store as part of expansion" 6/17/2008
- ↑ 11.0 11.1 11.2 11.3 The Labor Research Association 7/5/2005
- ↑ "Wage Against the Machine" 6/27/2008
- ↑ 13.0 13.1 13.2 Wal-Mart Stores (WMT) Annual Report 2009
- ↑ COST Q4 2008 Report
- ↑ 15.0 15.1 BJ's Wholesale Club Annual Report 2008
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