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3 Terrible Reasons to Sell Costco

By Daniel B. Kline - Feb 14, 2018 at 9:31AM

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The chain does not follow the same rules as traditional retailers.

Costco (COST -0.54%) has been a bright light in a somewhat bleak retail environment. While many chains are closing locations (including chief rival Sam's Club) and some are going out of business, the warehouse club has thrived.

The retailer has continued its slow, steady expansion while growing its user base. It has also, at least recently, done a good job at moving itself into the internet era by improving its website and adding multiple delivery options, including a same-day delivery partnership with Instacart.

Despite that, Costco stock has been somewhat volatile. It tends to move negatively whenever a major rival makes a move, such as when Amazon (AMZN -2.78%) bought Whole Foods. Of course, eventually Costco's share price corrects itself, but people seem to be selling for short-term reasons. Here are three shortsighted reasons some investors might be selling Costco.

A grocery cart in an  aisle of a wholesale store

Image source: Getty Images.

1. Fear of Amazon

Amazon has moved into brick-and-mortar retail with Whole Foods, and it may buy another chain in 2018. That's probably bad for grocery chains, but it has no impact on Costco.

The warehouse chain makes most of its money (about 75%) from memberships. It has maintained a 90% renewal rate despite a June 2016 price increase and has importantly grown its pricier executive membership base.

Costco's main goal isn't to get customers to shop more. It's to get them to renew their memberships. In many ways that works like a gym, where the prospect of saving keeps people on board even if they don't use their membership that much.

Amazon offering good prices and having a brick-and-mortar presence won't cause Costco customers to drop their memberships. So far, it has not even caused members to shop at the chain less, given that Q1 comparable-store sales rose by 10.5% and digital sales increased by 43.5%.

2. The retail apocalypse

Another worry that has caused some people to doubt Costco is that the retail apocalypse causing stores to close will make it less likely for consumers to leave their home. Yes, there may be openings at the mall and some barren strip malls.

That, however, has not impacted Costco stores, which are destinations in and of themselves. Consumers go there for value, but they also go there for the joy of discovering a bargain, and for the sampling, cheap food, and other in-store activities. That's not likely to change because other retailers are struggling. In fact, having less brick-and-mortar competition could cause Costco members to visit more often.

3. Comparable-store sales

While Costco crushed it in Q1, the chain will inevitably have a quarter where comparable-store sales slow down. That may cause some analysts to predict doom and gloom about the chain's ongoing prospects.

Comparable-store sales trends, however, are not always a sign of a company's health, or at least not an important one. Dig deeper and look at the membership numbers. If renewal rates remain around 90% and membership counts continue to move higher, then it's OK to overlook same-store sales.

Costco is not a traditional retailer

Remember that Costco is a club where members pay a fee in exchange for really good prices. That's a different business model than most retailers use, and it has different metrics for success.

Many casual observers won't understand what actually makes the company tick. That makes the company vulnerable to short-term negative moves, but ultimately those dips will likely correct as the market catches up on understanding the real numbers that drive the chain.

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Stocks Mentioned

Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
COST
$481.75 (-0.54%) $-2.62
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$113.22 (-2.78%) $-3.24

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