Costco's (COST 1.42%) revenue and earnings figures for its fiscal 2023 third quarter (ended May 7) might have disappointed Wall Street analysts, but this is still a great business. It has a loyal customer base and a strong economic moat. And shares have made for a wonderful investment, rising 148% over the past five years.
You might want to add Costco to your portfolio right now, even though it has underperformed the S&P 500 over the last 12 months. But before you buy, you must deepen your understanding of the company.
Here are three things the smartest investors know about this top retail stock.
1. Unique business model
With its 852 warehouses scattered across the world (most in the U.S.), Costco is not unlike a typical big-box retailer. It sells a wide assortment of popular branded and private-label products at low prices, and it has an e-commerce presence.
But Costco's differentiator is that it operates a membership-based model. Only customers who pay the annual fee for a Gold ($60) or Executive membership ($120) can step foot inside a warehouse to shop. This gives Costco a high-margin and recurring source of revenue while also driving customer stickiness. Members certainly see the value in this offering, as the worldwide renewal rate consistently hovers around 90% on a quarterly basis.
All of this helps support Costco's cost advantage, which is the key source of its economic moat. Its ability to negotiate better terms with suppliers, who have no choice but to do business with the world's third-largest retailer, translates to low prices for members. And this helps to drive more members, which results in more sales for Costco and even better leverage over suppliers. This favorable situation is difficult for smaller rivals to compete with.
2. Reliable growth
Between fiscal 2017 through fiscal 2022, Costco's total revenue increased at a compound annual rate of roughly 12%. And there was not a single year when annual revenue growth was below 7.9%, which happened in fiscal 2019. Those are remarkably steady gains that are all the more impressive when you consider that the past few years included a global pandemic, supply chain issues, and historically high levels of inflation.
To be clear, though, Costco is currently facing a bit of a slowdown. Its overall sales were up just 2% year over year in the latest fiscal quarter (the third quarter of 2023 ended May 7), with same-store sales rising a meager 0.3%. We're seeing similar trends play out at other huge retailers, so Costco shareholders shouldn't panic.
Looking ahead, Costco is poised to keep its long-term expansion going. The business plans to open 23 net new warehouses this fiscal year. Ten of these will be outside of the U.S. And by the end of fiscal 2023, there will be six Costco stores in China, a country management sees as a meaningful international growth driver in the future.
3. Tough competition
While Costco's special business model and steady growth are important aspects of the story, investors must also be aware of things going on in the overall industry. The retail sector is notorious for being extremely competitive, and Costco must find ways to continue successfully navigating this environment.
Walmart is probably Costco's biggest competition, more specifically with its Sam's Club stores. The membership count at Sam's Club hit a record in the most recent fiscal quarter. And Walmart raised full-year guidance thanks to strong performance in the most recent quarter. Because it's by far the largest grocery retailer in the country, it is positioned to do quite well as consumers stretch their budgets.
As e-commerce shopping becomes more popular, Costco also faces stiff competition from Amazon. The tech giant's Prime membership, with over 200 million members, is a viable alternative to getting a Costco membership. An analyst from JPMorgan Chase recently said that Amazon could become the largest retail business in the U.S. next year, showcasing just how dominant it has become. Costco has to do whatever it can to maintain its industry standing.
