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Why Costco Could Be a Loser in the E-Commerce Boom

By Jeremy Bowman – Updated Jun 1, 2020 at 9:30AM

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The warehouse retailer does a lot of things well, but online retail hasn't traditionally been one of them.

For years, Costco (COST 1.16%) has traded at a premium to the rest of the retail sector.

The warehouse giant has avoided many of the challenges plaguing its brick-and-mortar peers as the company's membership model provides a locked-in customer base and reliable cash flow that goes straight to the bottom line. At the same time, its reputation for bulk goods at rock-bottom prices continues to bring in customer in droves, and it consistently racks up strong same-store sales growth. No other warehouse chain has come close to the level of sales that Costco does, which has given it a competitive advantage in the subsector. 

However, the pandemic has brought about rapid change in the retail sector. In addition to the bifurcation between non-essential and essential retailers, and pressure in categories like apparel, e-commerce has boomed as shoppers who have been sheltering in place or are simply reluctant to visit a store are now shopping online. 

That's driven a spike in e-commerce with a number of online retail channels reporting Black Friday levels of traffic in April. Adobe Digital Economy Index reported domestic e-commerce sales up 49% in April from March, while online grocery saw an even bigger boom, jumping 110% from March to April. 

At least some of those new shopping patterns are expected to stick even as stores reopen and the economy normalizes from the initial impact of the pandemic. For Costco, this presents both an opportunity and a challenge.

The parking lot outside a Costco warehouse.

Image source: Costco.

A late start

Like its peers, Costco's e-commerce sales soared in its first-third quarter, rising 66%. In recent years, the warehouse chain has stepped up its e-commerce platform, partnering with Instacart to offer same-day grocery delivery to shoppers near Costco locations, and free two-day delivery on non-perishables with a $75 minimum to a broader swath of the country.

However, Costco's strategy has long centered around driving members to its stores rather than making it convenient for them to shop online. Unlike Walmart (WMT 2.18%) and Target (TGT 2.29%), Costco does not offer curbside pickup, a business that has boomed for its two rivals during the pandemic, and Costco also lacks the national footprint of those two retailers to facilitate same-day delivery to much of the country, especially rural areas. Like Walmart, Costco generates more than half of its revenue from groceries, so the company will need to compete in online grocery if that's were the industry is headed. According to a survey from Escalent, 38% of respondents said they would continue to shop online for groceries at the same level or higher after the pandemic.

On the recent earnings call, CFO Richard Galanti again explained that despite strong growth in e-commerce and its recent acquisition of Innovel Solutions to provide last-mile delivery and installation, it's still in the company's best interest for shoppers to come into its stores. Galanti said, "We still want you to come in. You're going to buy more stuff when you come in." The CFO also played down a desire to get into "click-and-collect" service, using its stores as a pickup point for online shoppers, even though that method is cheaper to provide than delivery. 

Slowing store growth

Costco's growth has historically come from comparable sales and new store openings, but Costco now seems to be pumping the brakes on new stores. Through the first three quarters this year, the company has added just five stores so far this year and has no other openings planned soon, according to its website.   

By contrast, Costco has added at least 20 new stores in each of the last five years. 

Galanti said last year that new store growth could slow modestly over the next decade, so it's unclear if this year's weak growth is an anomaly or a reflection of a new strategy. Walmart, notably, brought new store openings to a halt a few years ago after years of breakneck store growth in order to invest in e-commerce and store improvements like grocery pickup. Costco may be following in those footsteps.

Investing in e-commerce is a smart move for Costco, but its chief competitors, Walmart, Target, and, of course Amazon, have a significant head start over the warehouse retailer and have adapted their business models accordingly. Costco lacks the national footprint as well as curbside pickup, and management still sees bringing customers into the store as key to its success. The warehouse retailer simply isn't as well-suited to e-commerce.

Costco's disadvantage here shouldn't alarm investors. There's still plenty to like about the stock, including its rock-solid membership model and loyal customers, but the stock still trades at a significant premium to Walmart and Target. Today, Costco fetches a P/E of 36, compared to 24 for Walmart, and Target at 19. 

Costco still has to earn that premium. Investors should keep an eye on the company's ability to keep traffic coming into its stores and watch if the online grocery boom sticks as lockdown conditions ease.

 

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jeremy Bowman owns shares of Amazon and Target. The Motley Fool owns shares of and recommends Adobe Systems and Amazon. The Motley Fool recommends Costco Wholesale and recommends the following options: short January 2022 $1940 calls on Amazon and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
COST
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Walmart Stock Quote
Walmart
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Target Corporation Stock Quote
Target Corporation
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Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$115.88 (2.55%) $2.88
Adobe Inc. Stock Quote
Adobe Inc.
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