Costco Wholesale Corporation (NASDAQ:COST) faces bigger problems than a monthly revenue miss that sent shares down $6 , or 4%, after the numbers were reported on Sept. 1. The company said it had revenues of $8.65 billion in July, against $8.64 billion a year earlier and that 12-month trailing revenue of $107.16 billion was up just 2% from a year earlier.
A bigger problem is that Costco’s primary market of upper middle-class suburbanites is aging out, and their kids are moving into smaller city dwellings, often without cars.
The same efficient marketplace that let to its success is killing the sales and middle management jobs it needs to keep selling.
COST currently operates 708 warehouse stores, 496 of them in the U.S. and 90 more in Canada. Its North American sales footprint is approaching saturation, and it is moving cautiously to expand in other developed markets based on cars and suburbs.
Costco’s business model is to deliver savings to customers willing to “break bulk’ in their own homes. Its warehouse stores are sited in wealthy suburbs, usually at major freeway intersections, and customers come by every few weeks with a list of essentials to load up, often picking up some luxury goods along the way.
The question investors should be asking is how long its business model can succeed, and whether it has a second act.
Costco Complacency
So far, most COST analysts are focused on the details of its reports, and not threats to the business model. Guggenheim has a neutral rating on Costco stock, noting that food prices have recently declined and gas prices remain low, depressing revenue. BMO Capital Markets has an outperform rating on the stock, with a $180 price target and other analysts seemed to see the low numbers as a buying opportunity.
But COST is suffering from a slow leak caused by a changing economy. Jobs based on economic friction are slowly being replaced by apps and the high-end jobs being found by younger workers are generally in cities or around university campuses. The new careers bring a new lifestyle, with smaller apartments, shorter commutes and a greater premium on space and time.
Costco delivers savings in exchange for the time it takes to load up a car and break bulk in a large home. But the new careers don’t lend themselves to either big cars or big homes. In most large cities, growth near the center is now matching, or exceeding, growth at the edge. COST is a creature of the edge city.
Can COST Change?
Costco’s fuel problems are well reported but often misunderstood. Fuel sales are down not just because prices are down, but because driving is not increasing. COST’s business model has been based on suburban auto traffic.
In recent earnings calls, Costco executives admit margins on online sales are greater than those in stores, that online sales were up 19% year-over-year in the second quarter alone and that this represents less than 5% of total revenues, meaning there is room for growth. But there is no urgency on this front. It is focused on big ticket goods that are supplements to what it sells in stores.
From the point of view of a company not looking to change, this makes sense. Successful e-commerce requires that merchants break bulk in their warehouses. Scaling it requires investment and commitment.
COST can go along this way through 2017 and maybe through the end of the decade, but at some point, changing demographics and work styles have to catch up with it. The company, and its analysts, appear unconcerned. COST shareholders should be concerned.
Dana Blankenhorn is a financial journalist who dabbles in fiction, his latest being The Reluctant Detective Travels in Time.) Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. At the time of writing, he owned shares in COST.
