How Costco crushes its competitors

The secret lies in its membership fees.

By Jonathan Berr Mar 13, 2013 9:44AM
Shares of Costco Wholesale (COST) moved up after the warehouse retailer's recent better-than-expected earnings report. The company's prospects seem to be improving as the economy continues to rebound.

The secret to Costco's success is simple: It profits from membership fees and not on the goods it sells.

 

"They sell fuel at a loss and probably sell food at cost," Morningstar analyst Michael Keara says in an interview with MSN. One of the chain's many fans, he estimates that Costco's markup is half of its big-box competitors.

 

This gives it a huge advantage over rivals such as Wal-Mart (WMT), Target (TGT) and grocery chains because Costco doesn't need to raise prices to improve profits. It just needs to attract more members, which is something it seems not to have a problem doing. 

 

Membership revenue surged 15% in the most recent quarter as Costco benefited from a free  increase. It sold lots of other stuff as well. Excluding gasoline sales, Costco's same-store sales gained 5%. This key metric of sales at stores open for at least a year beat the performance of Wal-Mart's U.S. locations and Target stores. They eked out gains of 1.2% and 0.4%, respectively.

 

Costco, though, isn’t just for bulk groceries. It offers a mind-blowing variety of products and services ranging from fresh produce to travel deals to -- believe it or not -- caskets. Budget-conscious shoppers find bargains on staples such as toilet paper and soda, while wealthier consumers get good deals on big-ticket items such as TV. The chain truly does have something for everyone.


In the latest quarter, which ended Nov. 25, Costco opened five new locations, and it plans to open five more in the second quarter and nine in the fourth.

 

Some on Wall Street, though, think that Costco may be running out of gas. The stock hasn't exactly been a barn-burner, gaining about 5% at a time when the stock market continues to post record highs. The average 52-week price target on the stock  is $105.70, near its current price.  It trades at a price-to-earnings multiple of 25.43, a five-year high.


Others, though, see better times ahead and recommend investors add Costco to their portfolios.

 

Keara, for one, recently upped his fair value estimate on Costco to $110. Trey Hays of Hodges Capital Management tells MSN that the stock has 10% to 15% upside potential from current levels. "That would not surprise me at all," Hays said.

 

Costco has proven the naysayers wrong in the past and may do so again in the future.

315Comments
Mar 13, 2013 11:50AM
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Let's see. They 1)treat their workers well, 2)have good stuff, and 3) (to date) have not been involved in squeezing suppliers to bankruptcy. Sounds like a good company to do business with.
Mar 13, 2013 11:36AM
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Their products are very good. The better thing about the company is that they pay their employees very well $17 per hour. the CEO isn't a greedy pig.  He takes home 20x the average employee. Other businesses should learn form this example.  Henry Ford believed in paying his employees well also, he believed that his employees should be able to buy his cars, thus being able to sell more cars.
Mar 13, 2013 1:51PM
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Was in both Costco and Walmart yesterday.  One big advantage of Costco is that it appears that we are shopping with others of our species.  Too many customers of Walmart cause me to fear that our country is doomed.  Am puzzled that so many obese folks seem to think tatoos make them more attractive.  Not to my old eyes.

 

Mar 13, 2013 11:18AM
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How ANNOYING is it TRY to read an article and be hijacked by an ad!
Mar 13, 2013 1:15PM
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Not surprised at Costco's success vs Walmart, I belonged to both, the products are better at Costco, place is cleaner, and employees are friendlier and happier, prices are better, I will no longer shop at any Walmart, anywhere in part due to their inferior service and product but also because the way they treat their employees
Mar 13, 2013 12:17PM
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Costco is getting more members and will continue doing so. Consumers are switching from Sam's Club and WalMart because of the good treatment by the corporation of both the employees and the investors. The difference in the attitude of the company will keep more consumers joining. The veggies are as good as you can get anywhere else and better than "discount" grocery stores. And, there is no BS with the possible exception of the occasional hard sell staff person.

 

The employees who start at Costco tend to remain working there for a long time because of the respect they receive from the company, the rate of pay and the health care coverage.  Investors know that the corporation is not going to suddenly sell out or go bankrupt and will provide a reasonable sustainable rate of growth.. All in all, many of the marks of a good reliable American company.

Mar 13, 2013 11:26AM
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Maybe the membership fee increased, but I use my American Express card issued by Costco enough that I earn cash back that pretty much pays for the Costco membership. Costco rocks!
Mar 13, 2013 2:32PM
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It's called karma. You put good out in to the universe and you get good back.
Mar 13, 2013 1:59PM
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Costco Rocks, period. Go to Wal-Mart or Sams and experience depressed, unfriendly workers acting as if you are doing them a favor by shopping there, or worse yet...telling you how many hours they have left in their shift!
Costco workers-friendly, helpful, and effiicient.
Yes, I moved my membership from Sam's to Costco and I have never looked back!
Mar 13, 2013 10:55AM
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I wish there were one close to me, I'd give them a try.
Mar 13, 2013 11:36AM
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Personally having a Sam's club membership I think Costco affects more Sam's club the Walmart.

I know Sam's is directly related to WalMart I get that. But in reality both Costco and Sam's sell in bulk quanity where Walmart is more for the weekly shopper. As for Costco doing so well? I think people today generally think everything goes up and does not come down in price. So they think buying more can somehow save them money. My question is how much stuff drops in price through sales or promotions? I cannot speak on my experience with Costco. But from my experience with Sam's club not everything is such a great price there. In fact I bought several items thinking they were great buys and come to find out my small grocery store had much better weekly deals on those same items on a price per volume comparison.

Mar 13, 2013 12:13PM
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Please, please, please open a Costco in Central Arkansas.  I have to drive to Memphis to shop at Costco and don't get to go as often as I would like to.
Mar 13, 2013 11:24AM
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Use Costco along with my family members.  My children, now adults, are taking advantage of Costco.  One is single and says it saves in the long run. Have to shop once every 2-4 months.  Daughter married with two children say it also saves .  She shops every 2 months. 

 

Mar 13, 2013 4:17PM
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Costco proves that a company can pay a living wage with benefits to its employees, offer good products at good prices, and still make money for its shareholders.  Unlike so many businesses, they don't pay their CEO millions of dollars per year.  Do you see a correlation here?

 

Costco is obviously a great company, but with a P/E of 25 and PEG of 1.95 (for comparison, Apple's P/E is 9.7 and PEG is .51), the stock appears to be over-valued.  I recommend buying puts or writing covered calls to protect yourself from its inevitable decline when Wall Street decides to dumps it.

Mar 13, 2013 7:02PM
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Costco is becoming my favorite store. I can't buy everything in bulk but I buy meat and break the large packs into smaller ones when I get home. Paper goods, detergent and a multitude of goodies: books, clothes, bought a lined wool Michael Kors coat for 49.99, tennis shoes. You have to determine what works for you. If you have a large family, you can buy lettuce in bulk...if you're single, the lettuce will probably go bad. The membership fee is a small price to pay. I don't even know what it is. I usually pay at the register when it expires.
Mar 13, 2013 12:53PM
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Wanting one close to Bloomington would be fun but not gonna happen there city is in cahoots with Walmart.
Mar 13, 2013 11:25AM
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Location is eveything. Why burn an extra gallon of gas to save a buck?
Mar 13, 2013 12:25PM
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They should do well after a 15% membership fee increase!

 

Mar 13, 2013 1:29PM
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The only problem with Costco is that the nearest one is most of an hour away. ****'s is less then a half hour away. I would swap to Costco in a heart beat if it was closer. I will say, though, that ****'s does have excellent deli at an exceptional price. Half or a little over compared to chain groceries such as Price Chopper or Stop and Shop.
Mar 13, 2013 12:51PM
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Five more locations in the second quarter: two in Japan, one in Mexico, one in the UK, and one in Maryland. Doesn't really bother me tho, there isn't a Costco within 100 miles.

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