This Week's Duel
There's no question that investors are not going to get Celera-style stock leaps from Costco. That's fine; I'll happily settle for a solid 15-20% a year. Investors in for the long run should be amply rewarded, even at a P/E of 40 or so.
First, Costco has plenty of room for growth. With only 304 units, Costco has a lot fewer stores than many other big-box retailers. For example, there are 463 Sam's Clubs, and Home Depot has over 750 units. Costco has yet to expand to the Midwest, the Carolinas, or much of Texas. The fact that Costco is opening about 25 stores this year is a sign of methodical growth, not sloth. More importantly, the company plans to open 40 new clubs in 2001.
In addition, methodical openings aren't a problem because Costco has shown that it can open clubs where a Sam's Club already exists and take market share. In Detroit, which Costco did not enter until 1998, Costco's stores are doing $65 million in sales and recording double-digit comp-store growth, despite the presence of nine Sam's Clubs.
Costco also has plenty of room to grow internationally. The warehouse club concept travels well. In the U.K., for example, Costco has met with great success, after some initial confusion. Comparable-store sales in its seven U.K. units rocketed upwards by 28% in the fall quarter. Costco is planning four more U.K. units, and has just begun its operations in Japan.
In the U.S., the longer a Costco store remains open, the more business it does. As pointed out in an A.G. Edwards' research report (not as good as our own research reports, of course), Costco's average sales per club has increased at a compound annual rate of about 6%, from $75 million in 1995 to $94 million in 1999. (According to the same report, Sam's Clubs do about $50 million per club; Sam's earns less revenue with 463 stores than Costco does with 304). Some of Costco's oldest clubs in the Northwest United States continue to post double-digit sales growth. Rick is wrong to talk vaguely about comp-store sales "return[ing] to normal levels" -- these are normal levels. February's 14% figure is on top of year-ago numbers of 10%.
Growth will also come from Costco's ancillary businesses, which clocked in with 35% sales growth in the most recent quarter. They are where the real action is, not jewelry and computers. Costco plans to open 40-50 new gas stations at its existing locations annually, and still has hearing centers at only 66 clubs, and copy and print centers at only 15 clubs. As the company grows these businesses (which are higher-margin services, by the way), same-store sales will continue to climb.
Costco has plenty of other growth initiatives going for it: its new Executive Membership, which costs $100 per person and has attracted 150,000 members so far; its recent deal for a co-branded card with American Express, which will provide plenty of marketing opportunities; and some high-end travel services it will offer online and in-store. Speaking of the company's website, according to Costco's conference call, in the eight weeks following the holiday shopping season, Costco.com did $1 million in business per week, with an average order of $200. Not too shabby.
Rick also faults Costco for its store relocations, which he calls a sign of "botched executions." I don't think so. These relocations are either necessary expansions of current Costcos or rebuildings of leftover stores remaining from Costco's acquisition of Price Club. In San Diego, for example, Costco rebuilt an old Price Club warehouse and upped its weekly sales from $950,000 to about $1.7 million. That's not a sign of "botched execution."
I also disagree with Rick's take on margins. Gross margins improved six basis points in the second quarter, or 0.06%, and SG&A improved two basis points. These aren't huge jumps, but that's the nature of Costco: If you round off your numbers, as Rick seems to have done, you'll miss the point. Given that they'll have over $30 billion in sales this year, a few basis points here, a few there, and you're talking real money. In addition, the deal with American Express added some administrative expenses, as did its e-commerce initiatives, and its beefed-up office in Japan. Given all these new developments, it's surprising they reduced SG&A at all.
Finally, Rick says there are no "economies of scale" for Costco. The trends Costco is achieving -- sales growth in established stores, growth in average customer purchases, growth in ancillary businesses -- disputes this, but let's look at the numbers. Costco's return on equity has improved from 13.2% in 1995 to 16.5% last year. And while Costco's total assets have increased by 69% from 1995 to 1999, net income jumped by over 150%. I'll take those economies of scale, happily.
Attention, Costco shoppers: Next time you're getting your family-size toilet paper mega-pack, consider picking up a few shares on your way out.
This Week's Duel