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If Costco Doesn't Think It's Amazon-Proof, Why Should You?

By Rich Duprey – Updated Nov 22, 2016 at 1:59PM

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There are still some areas where it is largely immune from online competition.

Although you can buy most anything online these days, Costco believes its warehouse clubs still provide unique points of differentiation that make it a better bet than Amazon. Image source: The Motley Fool.

Analysts repeatedly argue that Costco (COST 1.33%) is immune to the threat posed to retailers by (AMZN -0.88%): Despite the e-commerce leader's dominance in tech gadgets and just about every other line of business it gets into, Costco relies heavily on sales of groceries and gasoline. Those products don't translate well to Amazon's business model, so Costco is shielded from competition -- or so the thinking goes.

Yet in its most recent earnings conference call, CFO Richard Galanti dismissed the notion there's no threat from the online sales king, saying "We don't buy that for a minute."

So if Costco itself doesn't think it's Amazon-proof, why should you?

Not exactly a Man of Steel

Perhaps because there are varying degrees of resilience. Like the Kevlar vests worn by police officers that are more correctly termed "bullet-resistant" rather than "bulletproof," maybe it would be better to say the warehouse club's business model is resistant to most of Amazon's forays into retail. Most, but not all.

Galanti would probably agree. Although he's said "we expect we are going to be impacted less," he admits Costco has lost sales to internet rivals, even if the financial chief says the retailer has come out ahead more often than not. Here are a few reasons for his confidence:

  • Groceries: Not everyone will choose delivery for their fresh foods, so Costco will make sure its produce and groceries are a reason customers come to the store.
  • Apparel: Where many apparel retailers are being hurt, Costco says it's in its fourth year of compounded growth that annually averages in the mid-teens.
  • Media: Videos, CDs, and books -- which arguably should be in Amazon's wheelhouse -- remain very strong for Costco.

The CFO says that "at the end of the day, we will expect that the internet in general is going to take its percentage of different categories," but Costco will hang tough.

Image source: Getty Images.

Costco's kryptonite?

Yet even among its strengths there remain issues Costco investors need to be cognizant of.

Gasoline, for example, does differentiate it from Amazon, but fluctuating fuel prices play havoc with Costco's performance. When the price per gallon is up, it naturally inflates the wholesale club's net sales, but lowers its gross margins. Conversely, a low-price environment such as we're in now has the opposite effect, and can weigh on comparable sales as well. In the recent fiscal fourth-quarter report, Costco said lower pricing coupled with negative currency exchange rates hurt comparable sales by 200 basis points.

Deflategate in Aisle 3

Just as with gasoline, rapidly falling food prices can take the wind out of Costco's sails -- and sales. Subtract the effects of gas and currencies, and Costco's full-year comps would have been up 3% for the period instead of just 1% -- but they could have been higher still, had they not been hit by the deflation occurring outside of gasoline. Fresh-food prices were down by mid-single digits while items like beef and pork were down anywhere from 5% to 10% from a year ago.

Amazon also has been investing heavily in some of the categories the warehouse club deems its strengths. The e-commerce leader only has a 1% share of the huge $800 billion grocery market at the moment, but it owns the online grocery space with more than a fifth of the market, almost twice as much as second-place Wal-Mart. And Amazon also just lowered the cost of its grocery-delivery service, as well as announcing plans for convenience stores to make its fresh groceries available to more people. A move into bricks-and-mortar is a serious threat to Costco's dominance.

Reason for hope

Yet the wholesale club does possess other niche departments like eyeglasses, travel, and its pharmacy business that still set it apart from the internet giant; taken as a whole, they represent about 16% of total revenues.

Because Costco seemingly goes out of its way to dissuade customers from shopping online, believing it benefits from customers being able to see and touch the merchandise, it unnecessarily handicaps itself. Amazon might not be a Costco-killer, but that doesn't mean a stray bullet can't still pierce its armor. That means investors should no longer believe that it's enough for Costco to be Amazon-resistant, let alone Amazon-proof.

Rich Duprey has no position in any stocks mentioned. The Motley Fool owns shares of and recommends and Costco Wholesale. 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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