Momentum Is Returning for Costco Wholesale Corporation

Costco is showing that its winter sales slowdown was just a fluke.

May 12, 2014 at 6:30PM

Like all brick-and-mortar retailers, Costco Wholesale Corporation (NASDAQ:COST) has come under scrutiny from investors who wonder whether the growth of e-commerce will disrupt its business model. After rallying steadily in the first few years following the Great Recession, Costco shares have barely budged in the last year.

COST Chart

Costco 5 Year Stock Chart, data by YCharts.

Investors were particularly concerned about fairly weak comparable-store sales growth at Costco this winter. However, since spring arrived, Costco has posted very strong sales results for two straight months. This suggests the company remains as strong as ever, and will continue to be a solid choice for long-term investors.

Costco vs. Amazon
The rapid rise of e-commerce -- and particularly Amazon.com (NASDAQ:AMZN) -- poses a potential challenge for Costco. In fact, Amazon is becoming more and more like Costco. Its Prime program offers free fast shipping on almost all purchases, and the "Subscribe and Save" program gives customers lower prices on everyday items that they need to replenish regularly.

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Amazon's Prime program is quickly making it a legitimate Costco competitor.

In other words, a Prime membership is increasingly becoming a substitute for a Costco membership. Amazon's recently announced Prime Pantry program is pushing it further into the food category nationwide, and in a few cities, it offers grocery delivery through AmazonFresh.

Costco's main weapon in the fight against Amazon.com is price. Costco's selling, general, and administrative expenses have averaged less than 10% of revenue in recent years, allowing the company to survive on razor-thin gross margins. Amazon has no hope of matching that number; it spends nearly 10% of its revenue on shipping costs alone!

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Some shoppers might pay a little more to avoid hauling bulky packages home from Costco.

However, while Amazon cannot match Costco's prices, it offers door-to-door delivery. Since Costco sells most items in bulk, many customers could quite reasonably choose to pay a little more to Amazon for the convenience of not having to drag heavy items home.

Slowing sales?
During the winter months, a slowdown in Costco's sales growth seemed to validate the bears' concerns. For the 12-week quarter ending on Feb. 16, Costco's comparable-store sales rose just 3%, or 5% excluding the impact of gasoline price and foreign currency fluctuations. By contrast, comparable-store sales rose 6% in FY13.

On Costco's Q2 earnings call in March, CFO Richard Galanti stated that most of the shortfall in sales came in the first four weeks of the quarter. He attributed the issue to a shift in the timing of Thanksgiving, which led to fewer shopping days in the high-volume holiday period between Thanksgiving and Christmas. Severe weather in January and February also depressed sales somewhat.

Not so fast
The coming of spring has shown that Costco's problems were caused by these unusual factors, rather than any secular slowdown in growth. In March, comparable-store sales rose 5%, or 7% excluding the impact of gasoline price and foreign currency fluctuations. Results were boosted by the shift of Easter from March to April, which added a day of sales.

In April, Costco saw a corresponding negative impact from having one fewer selling day because of Easter. Despite that headwind, comparable-store sales rose 5% last month (with or without the impact of gasoline price and foreign currency fluctuations).

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Costco's sales momentum has returned this spring.

These data points followed a broader trend of strengthening retail sales data this spring. Backing out the impact of the Easter shift, Costco's comparable-store sales trend has returned to the roughly 6% growth level seen in FY13 for the last two months. This implies competition from Amazon has not had a material impact on Costco's growth yet.

Price is a huge advantage
In the long run, I believe Costco's ability to offer the lowest prices of any retailer will be sufficient to fend off competition from Amazon.com and other discounters. With annual sales of more than $100 billion (and a high-single-digit revenue growth rate), Costco's purchasing power will allow it to get great deals from suppliers. Meanwhile, its warehouse model keeps operating expenses to a minimum.

The result is that Costco can make money with very low markups, keeping its prices unbeatable. Some consumers may pay a little more for the convenience of delivery from Amazon, but most people will continue to make price their first priority. This puts Costco in a good position to resume its streak of market-beating performance for investors.

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Adam Levine-Weinberg owns shares of Costco Wholesale. The Motley Fool recommends and owns shares of Amazon.com and Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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