Is Costco stock a COVID-19 winner?

Companies and indices mentioned:

In this week’s stock selection piece, I take a look at the often misunderstood bulk retailing business Costco Wholesale Corporation (NASDAQ: COST).

Costco a beneficiary of bulk buying

Similar to Woolworths (ASX: WOW) and Coles Group (ASX: COL) Costco has performed reasonably well throughout COVID-19 shutdowns, benefitting from hoarding. Its business model of offering incredibly low prices for bulk purchases was the perfect fit for consumers.

Costco sells all kinds of food, automotive supplies, toys, hardware, sporting goods, jewellery, electronics, apparel, health, and beauty aids, as well as other goods. The company has a unique business model in that it is structured as a club, selling memberships for around USD$60 per year. These memberships account for some 70% of earnings (EBIT) and are required for anyone wishing to shop either in person or online. The Costco group has over 780 stores across the globe, but with most revenue sourced from the US (73%) and Canada (14%).

After launching in 1998, Costco has slowly built up a store network of 12 in Australia, and I have little doubt everyone knows someone who is obsessed with their bulk buying, in-house product range. Such has been the company’s success in expanding globally that the Costco share price has averaged an 18% annual return over the last five years.

Ongoing growth

Costco offered up strong results despite COVID-19, reporting recently that its US comparable store sales was up 8%, and its International division reported results up 12%. Costco also sells petrol at 75% of their big-box warehouses. Some 40% of the company’s sales continued to be sourced from food and general items, with 18% from fuel, fresh food from 13%, and hard lines or hard products at 16%.

Indeed, Costco’s results have been impressive, with a constant increase in revenue from $129 billion in 2017 to $141 billion in 2018 and $152 billion in 2019. Investors have benefitted from faster global expansion and some 200 of its over 800 stores are now located offshore. Interestingly, only 4% of global sales have traditionally been online. This is, however, beginning to change.

According to Morningstar, Costco’s digital sales rose 66% on an adjusted basis and nearly 100% in March. The company is benefiting from considerable protections from digital rivals that should also act to limit its long-term e-commerce potential. Its Australian e-commerce offering is also up 30% for the year.

It’s all about ROIC

Costco has consistently delivered strong returns to shareholders, with Return on Invested Capital or ROIC averaging in the teens for most of the last decade and currently sit around 17%. This is similar but slightly higher than Woolworths’ result of around 14%.

COST is by no means a cheap stock as it trades on a P/E of around 30 times, which is not dissimilar to Woolworths shares at 27x. However, Costco’s model is a more scalable business model.

As with all grocery retailers, management is investing heavily into digitisation and their low prices along with membership fees should entrench them in the post-COVID-19 economy.  The membership base is almost cult-like and offers competitive advantages that will be needed as they seek global domination amid an uncertain economic environment.

This report was written by Drew Meredith, Financial Adviser and Director of Wattle Partners. To get in contact with Drew, click here to visit the Wattle Partners website.

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Drew Meredith

Drew Meredith

Drew is one of the founders of Wattle Partners. He is an experienced financial and investment adviser with expertise in self-managed superannuation funds, superannuation strategies, investment analysis and portfolio construction. Drew is a Partner at Wattle Partners.