Costco Wholesale Corporation

Moat: 4/5

Understandability: 2/5

Balance Sheet Health: 4/5

Costco is a membership-only warehouse club that sells a wide variety of merchandise at bulk discount prices, with operations spanning multiple countries and a growing e-commerce presence.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Costco’s business model revolves around generating revenue primarily through membership fees, followed by selling a curated assortment of goods at low prices and in high volumes to its members.

Business Overview

Costco’s core revenue streams can be categorized into membership fees and merchandise sales.

  • Membership Fees: This is a significant and recurring source of income, providing stability and predictability. Fees are collected from both individuals and businesses across different membership levels (Gold Star, Business, and Executive). Renewal rates are high, suggesting a strong value proposition for members. For the year 2023, about 92% of all members have renewed their membership, which shows the customer loyalty of Costco.
  • Merchandise Sales: Costco offers a wide range of merchandise categories, including foods and sundries, non-foods (such as apparel, appliances, and electronics), fresh foods, and ancillary and other businesses. This approach caters to a broad spectrum of consumer needs. A significant portion of their merchandise is under their Kirkland brand, for which there is no brand acquisition cost.
  • Geographical Segments: Costco has operations in the U.S., Canada, Mexico, Japan, the U.K., Korea, Taiwan, Australia, Spain, France, China, Iceland, New Zealand and Sweden, showing its international presence.
  • Retail Competition: The retail industry is intensely competitive, marked by the ongoing need for adaptation and value creation. The trends are increasing competition, including by online-only options, price wars, consolidation, and a shift toward personalized shopping experiences.
  • Economic Factors: Economic downturns, high inflation, and uncertain consumer spending continue to affect the retail environment. Costco’s business model has been shown to be reasonably resilient.
  • Supply Chain and Logistics: Supply chain challenges and logistical disruptions have become commonplace, and continue to be a significant factor in the cost structure of many retailers.
  • E-commerce: E-commerce continues to gain share in retail spending. Many retailers, including Costco, are investing to grow this segment. The online shopping experience is increasingly important in capturing and retaining customers.

Moat Analysis: 4/5

Costco’s moat primarily derives from the following sources:

Scale and Purchasing Power: Costco’s bulk-buying approach gives the company significant bargaining power with suppliers and enables it to offer goods at lower prices than its peers. This scale advantage is extremely difficult for smaller players to replicate. Costco is particularly powerful for branded goods that have consistent demand and a large market for. Its strategy is to only sell limited quantity of select products, which allows its high-volume demand to get the best price possible from its suppliers. A huge chunk of its revenues comes from selling merchandise directly bought from their suppliers under their Kirkland brand, which provides better margins and helps them achieve vertical integration, so a lot of the value is retained by the brand.

  • Membership Model: The membership model creates a steady recurring revenue stream and also fosters customer loyalty and repeat purchases, acting as a form of lock-in. This provides more flexibility to Costco on pricing and expansion. Moreover, their renewal rate is roughly 92% and the average member buys from them once a week, proving the stickiness of their membership program.
  • Low Prices and High Value Perception: Costco’s commitment to providing low prices coupled with its reputation for quality, builds consumer loyalty. They sell bulk sizes and at bulk prices which is a core part of their value proposition, and the company has shown they have pricing power (willingness to buy/price ratio) given their excellent value.
  • Strong Brand Equity: Costco is a well-recognized and respected brand name in the retail industry, associated with large selections and bulk buying. This brand recall makes them a go to name for people who want to purchase in bulk.

  • Geographically Well-Placed: They strategically locate their warehouses in densely populated and urban areas which helps them make significant revenue per store.

  • Limits of the Moat: Although their moat is quite strong, it does not translate into a high operating margin, due to their low pricing strategy. Also, the moat does not create pricing power that helps grow earnings over a longer period of time.

Risks to Moat and Business Resilience

  • E-commerce Disruption: Increased competition from e-commerce platforms could erode Costco’s sales if it doesn’t adequately grow their online sales. As of right now they are significantly behind their rivals. Moreover, supply-chain problems can also effect the business in negative way.
  • Macroeconomic Downturns: Given the discretionary nature of some of Costco’s offerings, a recession could result in a drop in membership signups, and reduce spending from existing customers. A bad economic environment could hurt Costco’s stock.
  • Increase in Costs: Increases in labor and transportation costs, if passed onto consumers, could cause less appeal to the membership and make them look somewhere else.
  • Changing Preferences and Tastes: Any company selling products can be hurt by changing preferences. Costco’s business model is not optimized for the fast-moving trends of the consumer preferences.
  • Competition: Although Costco has scale benefits, the retail industry is fiercely competitive. New entrants could chip away their business model over time.
  • Political and Regulatory Risk: Given Costco operates internationally, they are subject to political regulations from the countries they operate in, which can negatively affect their bottom line.

  • Inventory Risk: If Costco’s inventory management is not adequate enough for demand fluctuations, it can result in losses or write-offs.

  • Resilience: Costco has high switching costs from its membership and their low prices make it resilient for most investors. They have a track record of being relatively stable and recession resistant which allows for a stable business. They also generate a lot of cash flow from their operations, allowing for greater expansion and shareholder return.

Financials In-Depth

  • Revenues: For the 12-weeks period ended November 24, 2024, Costco reported total revenues of $57.71B, which represents a 7% increase compared to $54.24B from the comparable period of last year. Their net sales were around $56.73B and Membership fees was around $1.98B. Net sales contributed 98% of their revenue for this quarter. For the 12 weeks ended November 26, 2023, net sales was $52.76B, while membership revenue was $1.38B.
  • Gross Profit: The gross profit for the 12-week period ended November 24, 2024 was $6.768B, while the gross profit for the 12-week period ended November 26, 2023 was $6.246B. The increase was around 8.3%.
  • Operating Expenses: Costco had a total operating expense of $5.848B for the 12-week period ended November 24, 2024, compared to $5.328B for the 12-week period ended November 26, 2023, an increase of 9.7%.
  • Net Income: The company’s net income was $1.70B for the 12-week period ended November 24, 2024, compared to $1.38B for the 12-week period ended November 26, 2023.
  • Cash flow From operation is about $3.8B for latest quarter, which shows a robust profitability.
  • Profit Margin: Costco’s net profit margin was around 3% for 2024, which is similar to previous years. Their gross margin was around 12%. Even though their business model has a moat, the competitive nature of retail, coupled with their low pricing strategy, creates the low profit margins.
  • Return on Invested Capital: In the trailing twelve months period, their ROIC was around 22% (including goodwill and acquired intangibles).
  • Historical Trends: Their sales have shown growth year after year, especially given they keep adding new warehouses. This shows that the company’s moat is growing and sustainable.
  • Long Term Debt The total long term debt of the company stands around $6.0B for the latest reported balance sheet. Their revenue and cash flows both show the ability to easily clear the debt burden. They also hold around $17B in cash and short term investments, further improving the health of the company.
  • Shareholder Returns: Costco has a regular share buyback program to offset stock dilutions from their stock plans and other reasons. Their most recent share repurchases are 6.2M shares at an average price of $669.9 per share.

Understandability: 2/5

Costco’s business model is relatively easy to grasp—a members-only warehouse club offering a wide variety of products. However, understanding all the nuances of their strategy to provide value, the industry, and how they are affected by their specific geographies, is complicated and requires deep knowledge of the financial statements. I am giving it a understandability rating of two.

Balance Sheet Health: 4/5

Costco has a solid balance sheet, which allows the company to take on new expansion plans. I am giving it a 4/5, because while it has an excellent balance sheet, it has certain risks associated with its retail business model, which might change in the future.

  • Solid Cash Position: They currently hold about $17B in cash and short term investments, which will enable more growth.
  • Good Debt Coverage: With debt at about 6B, their cash flows and current profits clearly imply that their debts are easily payable for them.
  • Consistent Dividends: They have been paying dividends since 2004. Moreover, they are committed to increasing it for the future, which is a great indicator that they want to give money back to shareholders rather than reinvest in unprofitable opportunities.
  • Share Repurchase: They have a solid share buyback program which allows the company to offset stock dilutions from their executives receiving options and also reduce the amount of share outstanding, which is good for the share value.

Concerns/Controversies

  • Declining Growth Rate: The company’s recent slowdown in same store sales in Q1 of 2024 is indicative of a market slowdown. This is a point to be noted, because even though their business model is relatively resilient to economic slowdowns, it cannot be entirely immune.
  • Supply Chain: Macro-economic risks in other parts of the world, where most of their suppliers are, present some problems for the company’s operations.
  • Market Valuation: Costco’s current market valuation shows it to be relatively overvalued, so any overvaluation can be considered dangerous for an investor.

Management’s View

  • Focus on Core Strategy: The management has emphasized their continued focus on the core operations by providing better and more unique value to their customers with new and unique products and services.
  • Price Increases: Management has indicated that prices are slightly increased on products due to inflation in different countries and labor costs, they are closely monitoring the effects of the same to offer best value to their shareholders.
  • Continued Expansion: The company is committed to new warehouse opening, expansion and modernization. The management also understands the needs to expand their e-commerce presence, to better serve a wider customer base.
  • Member Value: Management has reiterated that their focus is on creating the best long-term value for their membership base, and providing them with new and unique products.
  • International Growth: The company has shown commitment to growing international operations in existing markets and also new ones.