3 Reasons Costco Will Eat Wal-Mart's Lunch

Costco (NASDAQ: COST  ) has been one of the most remarkable success stories in discount retail over the last years. However, the stock has risen by 30% in the last twelve months, and company trades at a considerable premium versus other players in the industry, so investors may be wondering if Costco has room for more upside.

The good news is that this premium valuation is well justified, and the company has plenty of room for growth, so the case for investing in Costco is as strong as ever.

The premium
When comparing Costco against industry peers like Wal-Mart (NYSE: WMT  ) and Target (NYSE: TGT  ) , the company is looking quite expensive with a P/E ratio above 25.3 versus ratios in the area of 14.8 and 15.4 for Wal-Mart and Target, respectively.

Looking at past performance, this premium is easy to understand since Costco has outgrown the competition by a wide margin over the last years.

And the trend is not reversing; Costco continues gaining market share according to data for the last quarter. Costco reported a 5% increase in U.S. same-store sales excluding gasoline prices for the quarter versus a decrease of 0.3% for Wal-Mart in the U.S. and a growth rate of 1.7% for Sam´s Club in the U.S. excluding fuel

Target is also losing ground to Costco, the company reported an increase of 1.2% in U.S. comparable-store sales during the last quarter. 

Still, the past is only a prologue to the future, the main question to consider is if Costco can justify its premium valuation or not on a forward looking basis.

One of a kind
While the competitive environment is fierce, there are three main reasons why Costco holds a definite edge. First, the company has an innovative business strategy implemented by a high-quality management team that sets it apart from the competition. Costco makes most of its profits from membership fees while selling products at zero profit or even at a loss. This generates considerable advantages when it comes to cost competitiveness, a key factor in the industry.

Second, the company chooses cost efficiencies over product variety when making inventory decisions, another source of pricing advantages for Costco versus the competition.

Third, even if the company strives to keep costs as low as possible in different areas, management understands the importance of paying a decent salary when it comes to attracting and retaining high-quality employees.

Costco´s hourly rate of $20.89 makes competitors like Wal-Mart look really bad with its substantially lower average rate of $12.67. This has material advantages for Costco when it comes to variables like employee turnover, and the long-term effects of having the best human talent in the industry could be remarkably important, even if they are hard to measure quantitatively. 

Since profitability depends heavily on membership fees and not so much on sales volumes, the company enjoys higher reliability and stability in its cash flows. Judging by financial figures, customers are quite happy with the benefits of shopping at Costco, so investors have good reasons to expect sustained performance from the company.

Membership fees grew by 3% during the last quarter, but that number expands to 6% when adjusting for factors like calendar anomalies and foreign currency effects. New member sign ups were up 9% year over year despite one less week in the quarter, and the company also reported a strong renewals rate of 86.3% during the last quarter. 

Costco has a smart business model and an innovative corporate culture which translates into happy employees and a loyal customer base; this is a big difference versus other companies in the industry.

Growth opportunities
Management is planning to ramp up expansion plans over the next years: the company intends to open 36 new warehouses in the next twelve months, half of them in the U.S. Even if some of these openings get delayed, this would still be a material acceleration versus 26 new locations, 12 in the U.S., during the last year. 

Demand has been consistently strong for Costco in the U.S, so management is doing the right thing by growing its store base in a more aggressive way to capitalize the opportunity. Regarding international markets, Costco is just giving its initial steps abroad, and it has ample room for expansion on a global scale over the coming years.

As long as the company continues gaining market share versus the competition, sustaining strong loyalty among members and growing its membership base, investors in Costco have good reasons to expect a new store openings to translate into healthy growth rates from the company in the middle and long term.

Bottom line
Costco is looking expensive in comparison to competitors like Wal-Mart and Target, but this is not an apples to apples comparison. The company has a different business model, superior competitive advantages and plenty of room for growth over the next years. The price may be higher, but so is quality, so don´t let valuation scare you away from a long-term position in Costco.

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Read/Post Comments (18) | Recommend This Article (7)

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  • Report this Comment On October 19, 2013, at 5:32 PM, jmc6237 wrote:

    There are several Walmarts nearby but it is a long

    way to Costco from me and I don't have to a yearly fee to shop there. We don't have to buy in large quantities for food etc

  • Report this Comment On October 19, 2013, at 6:37 PM, Ronmc2 wrote:

    "Costco´s hourly rate of $20.89"

    Costco's Hourly wage Tops Out at $22.50, so that's Nonsense. Motley fell for the Liberal Media trick of comparing a 19-year forklift operator to a standard Walmart Associate.

    That is like comparing the AVERAGE Upper Mgmt salaries of Walmart(including All the Waltons) to that of Costco.

    Both starting wage are about the same, but Costco's wage increases are quicker.

    Let's compare the starting wage of Each company's high school dropouts & Senior Citizens. Oh wait, Costco doesn't hire them, so who is the REAL Bad Guy?

    EDUCATE YOURSELF instead of regurgitating Liberal Spin by Googling the Answers that fit your Agenda.

  • Report this Comment On October 19, 2013, at 8:18 PM, andiconda wrote:

    Romnc@ listening to that white washed conservative talk radio again.. nice try but Costco is the balance needed in the workforce, especially in the under paid retail sector. Instead of using your anti liberal rant, look to them as an example. No a forklift driver at Costco, and walmart are not compensated equally.

  • Report this Comment On October 19, 2013, at 8:24 PM, Wetworkz wrote:

    As long as you're ranting on "inaccuracies" here-- it takes nowhere near 19 years to top out. Not to mention the bonuses afterward, which only add to the overall hourly. You may not like the statistics that prove it out, but the fact remains- the AVERAGE pay gap is huge. And where does it say a private company must hire the lowest qualified individual, if a better or more highly qualified applicant is available? Show me a company that purposely and willingly does that, and I'll show you a failure waiting to happen.

  • Report this Comment On October 19, 2013, at 8:27 PM, BenFE08 wrote:

    @Romnc

    Wonder if ANY of the Walmart/Sams employees have the same pay/benefits as Costco or will EVER have?

  • Report this Comment On October 19, 2013, at 8:40 PM, Radmasters wrote:

    The point of Costco is not to worry about how it treats its employees, the point is how it treats its customers.

    The biggest problem I have with Costco is the lack of privacy. Every single item that you buy from Costco is tracked to your account.

    They take your driver's license and copy it into their computers. It is not that I have anything to hide, but there is no valid reason for them to mandate that you lose your privacy.

    In addition, many of the "deals" at Costco can be matched or beaten.

    How can membership fees and selling products at or below cost be a good business model?

    I believe that the writer of this article didn't do enough or the correct research for it.

  • Report this Comment On October 19, 2013, at 8:56 PM, spintreebob wrote:

    Interesting that many who had a Walmart starter job went on to better jobs and remain loyal to Walmart, just like those who started at McDonald's and went on to better jobs are still loyal to McDonalds. Happy xemployees are great word of mouth advertising. Bad PR can destroy big business (Kmart, Ackman's JCP). But word of mouth builds it.

  • Report this Comment On October 19, 2013, at 11:47 PM, firemanjim478 wrote:

    Forget politics, a worker WILL make more money at Costco, look at 1 year workers pay and 20 year workers pay. Stop at a Costco and ask a worker about the over all job and benefits, Costco wins hands down every time. Un like Walmart, the workers are more friendly and know there products. I wish I had a Costco in my home town. It does matter how you treat your workers because that treatment will trickle down to sales and sales mean money and profit!

  • Report this Comment On October 20, 2013, at 1:07 AM, CrazyDocAl wrote:

    Why is it that the comment section at the fool always gets bogged down with issues not really related to investing. Costco has a business model that works. Every one I have seen is in a location where they don't have any close competition. WalMart is not really competition to Costco since Costco has a limited selection of items.

  • Report this Comment On October 20, 2013, at 1:10 AM, finnsters wrote:

    Sadly, many of you are either uneducated in facts or care to bash anything Wal-Mart related.

    One, Wal-Mart and Costco aren't competing for the same customer. Sams Club is Costco's direct.

    Target - why are they even discussed? Although, Costco does aim less for business than Sams does. If you have a business or a large family/needs, you buy what you can - as best quality as possible, and as reasonable as possible!

    Two, having been a Sams employee for over 20 years, our pay is very close to each other, as I have a good friend who works for Costco. They pay no more than Sams overall. I know for a fact that this line from our esteemed writer is crap (Costco´s hourly rate of $20.89). They do not start at that rate - that rate would be achieved in about 15 years. Sams benefits have always been as good or better, and stock performance for Wal-Mart since 1970 has made many private people and employees millionaires!

    Each stores environment is a direct reflection of their general manager, and we (my friend and I) have both seen the good and the bad.

    Costco has its pluses - as does Sams and Wal-Mart, since we are discussing all '3'. Our article author seems to be biased - as I am for my employer. Let me say if I had to do it all over again, I would not change a thing.

  • Report this Comment On October 20, 2013, at 5:23 AM, Jwhipit wrote:

    Lets get a couple things strait about costco shall we. I am an employee of costco since 2003, and am as happy as ever. Costco just came out with a new insurance plan with Aetna, that will be a LOWER cost than obama care (not much of a surprise as obama care is crap and will be a stepping stone for single payer health care, as the president has already said).Anyways back to Costco, Their pay to start has gone up over the years and when I started in 2003 it was $10.00 and I got a raise every 800 hrs worked, with about 6 steps before I was topped out at $19.83 an hr ( a supervisor atomaticly makes $1 over anyone that works beneath them) So after a year I made supervisor at 19 and was making $20.83 an hr. And after working for 5000 hrs total you start of with a $2500 (going all the way up to $5000) bonus every 6 months. We also get time and a half every sunday even if thats the only hrs worked for the week (you can work 48 hrs a week). We get 7 paid holidays (paid on your floating average of hrs worked) 3 floating holidays (paid on floating average as well) excellent healthcare. As well as 401 k contributions(in addition to any matching they do when you contribute) and matching dollar for dollar on your 401k.

    Not to mention the store opens at 10 so you dont have to get up to early and closes at 830 (6pm on sat and sunday) so you can still have a life in retail.We get free executive memberships and can give them to up to 5 people. We start out at 1 week paid vacation and can go up to 5 weeks paid, you can roll over 2 weeks (a total of 7 weeks if you dont use any) and get cashed out for the remaining hrs if not used. After 2 1/2 yrs of working here I was making about $21.00 per hr (adjusted each yr for inflation) and getting a $2500 bonus in the fall and spring on my checks. I did not use alot of my vacation and cashed it out, but when all said and done it was close to $62 thousand dollars, so who ever said that the wage in the article was comparing a 19yr employee at costco vrs a new hire at wall mart was greatly misinformed.

    Our average cashier is making over $50k a year, and I will guarantee that is far more than the average for Wall-Mart, not to mention our employee turnover rate is close to 5% each year. I am now a manager and am making close to $95k a year, bonuses and stocks, 401k company contributions, and company matching. We do hire plenty of high school drop outs, if they fit what we look for in an employee to offer the best possible experience to the customer. I love costco and think it is the best store in retail (for employees, and customers).

    So please if you are going to make comparisons from a friend that obviously does not work for costco because you would no that our top out rate (now $21.89) would take about 3-5 years to get (unless you make supervisor and skip the steps) depending on whether you part time or full time. And as far as hourly wages and top out rates and hrs to get there, we update our employee hand book every three years. And the starting wage is $12.50 to start and goes to $13 an hr after 90 days plus your eligible for 401 k and holiday pay.

    So please if you don't know the stats and say a friend works with a certain company make sure an actual employee does not see what you post, so they can correct you.

    And the reason why its interesting that all these employees from wal-mart and sames went on to bigger and better jobs was that they did not make as much as they felt they could and in my opinion did not like their jobs (as was the case with my brother who actually worked for wal-mart) and he was very frustrated at how they paid so little for what they expected him to do and when it came to raises they went off what a manager thought vrs Costco having it lined out with the number of hrs you work. Costco has an average employee of 13.25 years worked.Thats interesting, that they did not feel the need to move on. And if you have ever been to a Costco you know they are hard workers and intelligent and friendly.

    Just wish Jim sinegal was still our ceo, and that he wasn't a liberal, and supported Obama. But that aside, I cant list all the reason why Costco is great, I love working there and will so probably the rest of my life! Any more questions on Costco please look them up.

  • Report this Comment On October 20, 2013, at 6:18 AM, Jaws16101 wrote:

    I've never even seen a Costco store let alone went to one. Walmart price matches. Why would I go anywhere else?

  • Report this Comment On October 20, 2013, at 10:57 AM, pwkrp wrote:

    @Jaws16101, how can you compare if you have never been in a Costco, you can't. For years here in Hilo Hawaii we only had Walmart. Then Target open and now you will see how many people shop at Target. We have found prices lower at Target, people at Target will help you find something. The employes smile and always ask you if they can help you find something with a smile. Ask for help at Walmart, if you can find someone the will point to the direction of that item and say " I think it's over their somewhere" with no smile on their face. And when I lived on the mainland I went to Sam's club, and Costco with some friends and you can see the difference in the people at Costco, helpful and friendly.

  • Report this Comment On October 20, 2013, at 11:45 AM, jcon251977 wrote:

    I work at Costco and it only takes 4 years to top out. And EVERYONE is paid very well. And treated even better. We ALL make more than a shift supervisor (probalbly more than most asst. Store Managers) at Wal-Mart. Costco employees don't rely on Government aid to take care of their families.

  • Report this Comment On October 20, 2013, at 12:14 PM, Ronmc2 wrote:

    JWhipit-Thanks for setting us(including me) straight. As you can see, most of what I wrote was true(AVERAGE wage-$20.89, Nonsense, Payscale increase is quicker, hiring practices, etc.). I must agree better, but not great, benefits. I shop at ALL the stores-Costco(best quality), Walmart(best selection), Trader Joe's(best eccentricities), 99-cent store(BEST value for produce, holiday items), Target(cleanest, brightest, best Store-brand ice cream, Archer Farms).

    One thing you didn't bring up was firing bad employees. Almost impossible at Costco, so they just transfer them to other Costcos. That kind of Bureaucracy sometimes shows in specific locations, just as bad teachers end up transferred to the inner-city.

    Compare my comments to the gullible Liberal, Andiconda. Who was closer to the Truth?

  • Report this Comment On October 20, 2013, at 12:34 PM, Ronmc2 wrote:

    jcon-Goldman Sachs employees don't rely on Government aid, either. But Target employees do. Why no Target-bashing?

    Would you rather pay for SOME Gov't Aid for people who WANT to work(McD's, etc), or ALL the Gov't Aid due to Costco's selective hiring practices?

    To make as foolish a Strawman Argument as you-

    Walmart employs 1.4 Million in the USA. Costco employs 160,000 Worldwide. How much Gov't assistance is paid for the other 1.2 Million that Costco does NOT employ?

  • Report this Comment On October 21, 2013, at 7:58 PM, heather1970 wrote:

    I am a 20 year employee at Costco Canada, the top hourly wage is $25.15, most cashiers make $24.15 after 5 years and then the bonuses start every 6 months. The people pushing buggies that have been there over 5 years, make $22.35 great benefits, great pension. I have been able to purchase 3 homes over the course of 20 years due to my good income at Costco, no one will ever be able to tell me that they aren't a fabulous company to work for

  • Report this Comment On October 22, 2013, at 8:50 AM, adamjewl wrote:

    Costco has a better debt to equity ratio of 10% compared to 70% of Walmart. There are more interesting facts you must go through: http://goo.gl/UMXU8W

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