Costco Wholesale Corporation Proves Again That Brick-and-Mortar Retail Isn't Dead Yet

Costco remains one of the strongest retailers on the planet, despite having a very small e-commerce footprint.

Aug 7, 2014 at 2:57PM

Many of the top names in big-box retail have been suffering recently because of the combination of choppy economic growth and the rise of e-commerce. However, discount warehouse chain Costco Wholesale (NASDAQ:COST) is a big exception to the rule.

After a fairly slow start to the 2014 fiscal year last fall, Costco has returned to form in recent months. On Thursday, the company posted a 9% rise in sales for July. Costco's consistent high single-digit sales growth will allow it to maintain its industry-leading cost structure and produce solid long-term earnings growth.

Another good month
In the four-week July retail month, Costco's total sales rose to $8.55 billion from $7.87 billion in the prior-year period. Comparable-store sales (a measure that excludes the impact of opening and closing stores) rose 5%, consisting of 5% growth in the U.S. and 6% growth internationally. This was a tad worse than some analysts expected, but still a very good result.

Discount Retailers Costco Store Cost

Costco is posting consistent comparable store sales growth.

Excluding the impact of currency and gasoline price fluctuations, Costco's comparable-store sales would have increased 6% year over year in July. On this basis, Costco has posted very consistent growth in the last few months. Comparable-store sales excluding currency and gas price fluctuations grew 7% in March, 5% in April, and 6% in both May and June.

Some of the strongest categories for Costco last month were fresh foods and soft goods (like apparel) -- both categories posted high single-digit comparable-store sales growth.

In the fresh food category, Costco has benefited from high inflation in some items. A variety of supply issues have driven prices higher for meat (particularly beef), dairy, and eggs in 2014. Costco has taken advantage of its massive scale to keep its purchasing costs down, and it has passed those savings along to customers, driving market share gains.

It's all about brick-and-mortar
Costco's strong results aren't an indication that the company has "figured out" e-commerce more than its struggling big-box competitors. Last year, e-commerce represented just over 2% of Costco's revenue, and that percentage is growing very gradually.

Indeed, on an earnings call last December, Costco CFO Richard Galanti was very candid about the company's e-commerce plans. While Costco is working to implement new capabilities for its website, Galanti made it clear that the main focus continues to be brick-and-mortar sales. Growth will come primarily from adding warehouses and increasing sales per square foot.

E Commerce Amazon Box Amzn

Amazon.com is growing rapidly, but Costco isn't scared.

A sustainable model
Despite relying on an "old-fashioned" brick-and-mortar infrastructure, Costco's business model appears to be sustainable. The rapid growth of Amazon.com has not had an appreciable effect on Costco's business thus far.

For example, Costco's comparable-store sales growth last month was right in line with the 6% growth rate (excluding foreign exchange rate and gasoline price changes) it has seen all year.

Costco's growth rate has also been very consistent from year to year. In FY 2009, comparable-store sales grew 3%, excluding the impact of currency and gasoline price fluctuations. That growth rate accelerated to 4% in 2010 as the global economy recovered, and has remained at 6% for each of the last three years.

The reason for this strong long-term growth is that Costco has by far the lowest costs in the retail industry. In an industry in which limiting overhead and labor costs (also known as SG&A) to 20% of sales is considered great, Costco has driven its SG&A expenses down to less than 10% of sales.

With lower expenses than any and all competitors, Costco can consistently offer eye-poppingly low prices. This drives customer traffic and builds brand loyalty over time. In the long run, this will allow the company to steadily increase membership fee income (which produces the bulk of its earnings) and gain global retail market share.

Foolish bottom line
For the past two decades, Costco has been bulldozing competitors by striving to be the most efficient retailer in the world. This also allows it to have the lowest retail markups in the world. This is such a strong value proposition that customers continue to flock to Costco warehouses even as e-commerce grows to represent a larger proportion of retail sales.

If Costco manages to turbocharge the growth of its e-commerce business through infrastructure upgrades and other initiatives, it will be a great boon for shareholders. However, even without a strong e-commerce arm, Costco is a formidable retailer that should post steady sales growth for the foreseeable future.

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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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