Since Amazon.com, Inc. (NASDAQ:AMZN) announced its acquisition of Whole Foods Market, Costco Wholesale Corporation’s (NASDAQ:COST) stock has experienced a relative slump. Although it’s off recent lows, the stock price remains below its recent high in the $180 range. Now that Amazon and Whole Foods completed the merger, investors wonder where the competitive environment leaves Costco investors. However, many competitive advantages that remain with Costco are being ignored by investors.
Having long ago eclipsed Sam’s Club regarding sales per square foot, few dispute that Amazon is now Costco’s foremost competitor. And with the completion of the merger in late August, the company is already lowering prices at Whole Foods. The company began integrating Whole Foods with its newly-started Amazon Fresh division. It also promises Whole Foods deals that will be exclusive to Amazon Prime members. The data on how either company will be affected will not be known before the next earnings releases.
However, investors appear concerned as COST’s stock price tends to fall on any announcement from AMZN related to the merger. Groceries are a large part of Costco’s revenue, accounting for approximately 35% of its sales. Moreover, while Costco has moved into e-commerce at an increasing rate, it has not sought to acquire a large company in the e-commerce space equivalent to Amazon’s move into physical grocery stores. Also, Costco recently increased its annual membership fee from $55 to $60. Investors are also waiting on the data to see the effect, if any, on Costco’s approximate 90% average retention rate.
However, in offering a bargain price to investors, COST stock trades at a substantial discount to AMZN when the measure is the price to earnings (P/E) ratio. Amazon’s stock currently trades at approximately 250 times earnings, nearly ten times the average P/E ratio of general retailers, which stands at about 26. Even with earnings growth forecast at over 100% in both 2018 and 2019, Amazon’s P/E ratio leaves the stock vulnerable if any of the news or earnings-related metrics fall below expectations. In contrast, Costco’s stock trades at around 28, much closer to the industry average. While earnings growth is less impressive than Amazon, Costco retains a longer track record of producing earnings (Amazon experienced negative earnings as late as fiscal 2014), and Costco’s earnings are still projected to grow by over 12% in 2018 and just under 10% in 2019.
Moreover, Amazon appears to be experiencing some of the employee and customer relations issues often associated with Walmart (NYSE:WMT). Once regarded as a dominant player in retail, Walmart saw its reputation erode amid poor customer service and issues with employee relations. Evidence has emerged that Amazon could be on the same path. A New York Times article in 2015 alleged Amazon imposed difficult working conditions on its employees. The company has introduced programs such as its Pivot program to improve working conditions and productivity. However, it’s not yet clear if and how much the program will improve employee relations. Conversely, Costco stands out by never needing such a program in the first place. Costco has maintained a hospitable work environment. It’s one of the higher-paying employers in the industry and offers health benefits to 88% of its workers among other benefits. As a result, the company experiences turnover rates of under 6% for workers who stay over one year.
In addition, Costco’s product offerings and store experience are a customer draw investors may not be appreciating. Costco built much of its popularity around its Kirkland Signature brands, which have won favorable reviews on products varying from golf balls to batteries to olive oil. Costco also derives much of its popularity with exclusive and innovative products that inspire customers and offers them the chance to see or possibly buy the rare and unique. Among these offerings have been Russian caviar, an outdoor steam sauna, and rare paintings. While some of these products are out of the price range of most customers, it provides a customer experience that makes Costco a museum in a sense, inspiring customers to look in their stores instead of at a smartphone screen.
The completion of the Amazon/Whole Foods creates uncertainty among Amazon’s competitors, particularly Costco. The merger gives Amazon a bigger footprint in Costco’s traditional retail space than Costco has in the online space. When it comes to repeat purchases or small purchases, Amazon and other competitors will likely attract most of the business. However, if customers want a more reasonably priced stock, a company with strong employee and customer relations, or simply, the new and rarely available at a low price, Costco has little competition from Amazon.
As of this writing, Will Healy did not own a position in any of the stocks mentioned here.
