Forget Walmart and Target — Costco ‘Gets It’

by James Brumley | June 14, 2013 9:47 am

More often than not, financial media can answer investors’ questions with plenty of accuracy.

But that doesn’t necessarily mean investors are asking the right questions. Sometimes, we can get so consumed by a tightly focused premise that we end up missing a more important data nugget.

Case in point: For whatever reason, traders love to pit Walmart (WMT[1]) and Target (TGT[2]) against one another to find out which one’s the better company, and therefore the better investment.

It’s not an illogical exercise. The two hold the No. 1 and No. 2 value-retailer spots, and, for all intents and purposes, sell the same stuff to the same target market. And, it seems like one is named the victor of the mock contest as much as the other.

But what if neither Target nor Walmart is the top investment opportunity in the discounter space?

The Best of the Best

If you’re looking for the best way to play value-retailing, take a position in Costco Wholesale (COST[3]).

Seriously.

While it would be an overstatement to say Costco is a polar opposite to the likes of Target or Walmart, the company is cut from different cloth.

For starters, Costco only sells to club members, each of whom pays for the right to spend money at COST’s stores. Walmart’s Sam’s Club is akin, but clearly not the core business for WMT. Costco also provides a (and bear in mind, this is relative) much more polished, upscale experience for its customers.

Yes, you read that right — a wholesale shopping club that charges customers just to walk through the door to browse an admittedly limited selection is delivering a posh experience based on bulk-shopping standards.

You’ve got to figure it’s driving Walmart and Target nuts, too … especially Walmart. The odds of anyone paying a fee to shop at Walmart just to deal with bare shelves and poor service are somewhere right around zero (and it’s not like Walmart’s Sam’s Club stores are faring much better than the company’ namesake locales).

The proof is in the numbers.

Last quarter, Costco drove a 5% increase in same-store sales, and improved profits by 19% on a year-over-year basis. The quarter’s numbers just extend what has become a three-year growth streak for the top and bottom lines.

Perhaps the more interesting detail of Costco’s most recent quarter, though, is the fact that revenues from membership purchases grew by 12%. New signups grew by 19% on a YOY basis. The company’s membership renewal rate is still a solid 86%, despite a 10% increase in those fees late last year.

Just a sign of times that consumers are in need of a way to save money? Perhaps, but then, why did Walmart’s Sam’s Club membership income only grow by 1.6% last quarter? You can reasonably expect a minor difference in fee revenue, but for two organizations that basically do the same thing, the growth disparity suggests consumers see a major difference between the two.

And it’s not like those differences are trade secrets.

Why It Works, & Why It Will Keep Working

With just a superficial glance, Sam’s Club and Costco could be carbon copies of one another. A closer inspection, however, makes it relatively clear that Costco “gets” two critical things about the business that Walmart doesn’t.

  1. Service matters. Walmart’s labor woes aren’t exactly new news.[4] Complaints of weak pay in addition to most stores being understaffed are well-founded and well-documented. Costco’s treatment of employees is almost a diametrical opposite to Walmart’s, in that it pays workers a so-called “living wage” well above minimum wage. All told, the typical Costco store employee earns roughly $15 per hour compared to about $11 for Walmart workers. The end result, some believe, is a base of workers that care about keeping their job, as a job well done positions those employees for advancement within a company that makes a point of promoting from within.
  2. Merchandise efficiency. Although the estimates vary somewhat, some peg Costco’s annual sales per square foot of store space around $800, versus Sam’s Club’s annual sales of about $650 per square foot. If you’ve been in a Sam’s Club recently, you might know why — they’re looking more and more like a Walmart and less and less like a warehouse. That would be great if too many (and poorly presented) products weren’t making Walmart stores a mess. But Costco’s stricter adherence to the warehouse-club model proves less can be more. Higher sales per square foot also indicates the company is better-managed in many other ways, starting with sheer product selection.

Bottom Line

The secret of Costco’s success isn’t just doing two things well. It’s that those two things together make for a very compelling customer experience. That’s why the company has little to worry about from the likes of Walmart or Target.

Yes, it’s possible that Walmart — and Target to a lesser degree — could learn some key lessons and start to mirror Costco’s playbook. But expecting Walmart to start paying its workers more is like expecting the sun not to rise.

As for better merchandise management, that’s something that’s also been slowly whittled out of the Walmart/Sam’s Club operation over the past several years. It could take years to repair that problem.

Costco’s got little to worry about for a long, long time.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Endnotes:
  1. WMT: http://studio-5.financialcontent.com/investplace/quote?Symbol=WMT
  2. TGT: http://studio-5.financialcontent.com/investplace/quote?Symbol=TGT
  3. COST: http://studio-5.financialcontent.com/investplace/quote?Symbol=COST
  4. Walmart’s labor woes aren’t exactly new news.: http://investorplace.com/2013/04/walmart-is-learning-the-hard-way-that-service-matters/

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