Costco Wholesale: The Monopoly on Retail

Posted by Jacob Radke
August 11, 2023

Thesis: Costco is a massive retail shopping chain with 853 total stores as of May, with 587 in the US and 266 outside the US. Costco charges a subscription for members to gain access to the store. Members of the store tend to carry out large purchases as they buy in the chain’s bulk goods model. Costco also offers a credit card that can be used for in store and out of store purchases. I believe Costco’s business model sets it up well for continued success because of the nature of the consumer (buying bulk items) and the stickiness of the membership and credit card model.

A growing retail base

Costco total market capture in the US alone has not been realized. Even at 587 stores already, Costco could grow that number by an order of magnitude as it ventures into new markets and expands in existing markets.

Costco currently has 8 locations in Los Angles, a city with a population of 13 million people. A city of that size if Costco were to take over the majority of it’s market would require at least 40 stores, 5 times more than it currently operates.

In New York City Costco currently only has 2 locations. New York City has a population over over 9 million, which would mean that would require at least 30 stores, 15 times more than it currently operates.

There are 741 cities with a population of over 25,000 people, with surrounding rural areas that would be the perfect target market in some cases.

Costco’s locations in the US alone have the potential to increase five to ten fold over the coming decade.

Internationally, as the middle class grows, Costco’s dominance as the retail superstore could also serve to greatly expand it’s store locations.

A unique revenues and earnings opportunity

Costco currently has gross and EBITDA margins well below industry peers at 12.15% and 4.17%, respectively. However this is a unique selling point for the store.

Instead of spending billions of dollars on marketing campaigns, Costco simply marks up their products less than traditional retailers.

The nature of the recurring revenue to gain access to those lower markups is part of the true beauty of the store.

Walmart’s “everyday low prices” means lower markups on store items, while still trying to make a buck.

Costco is positioned differently. Costco offers tiny markups on product, but buys and sell those products in bulk allowing it to move a higher volume of it to consumers. That higher volume is what allows it to offer low prices. The “wholesale” to Walmart is the same, Costco has B2C’d the B2B wholesale business.

Membership revenue is “free” income to the company, it costs virtually nothing to issue new memberships and maintain them, that said it makes up a small portion of the business’s revenue, but makes up most of the business’s earnings, because of the nature of the low markups on goods.

In Costco’s quarter ending in May 2023, total revenue from merchandise was $52.604 billion and from membership fees it was $1.044 billion. Total earnings were $1.302 billion. Cost of merchandise was $47.175 billion, and selling, general, and administrative costs were $4.794 billion.

That $1.044 billion in revenue from membership fees came from a combined total of around 123 million worldwide members. The average number of members per US Costco store is around 150,000, which means at a 50% split between Gold and Executive members the average store’s membership revenue is around $13.5 million, and Costco’s annual renewal rate is >90%.

The defensibility

Costco is a consumer defensive company. It sells normal household goods including food, kitchen, lawn, garden, general pharmacy, furniture, etc. Traditional products that people still need to buy in the event of a downturn, and with their model of next to nothing product markups, Costco could stand to benefit from distressed shoppers.

With the majority of actual earnings coming from membership fees Costco doesn’t rely on more buyer activity, it just relies on new membership and keeping existing memberships.

Even if the consumer slows down on buying, Costco’s earnings should be pretty defensive against that by the nature of the recurring memberships.

Final Thoughts

Costco is one of the most interesting and unique large scale retailers in the world, and that is known by the investors in the company. Despite lower margins than peers, it trades for a premium to peers. However as noted above that is largely because the model itself is very sticky and faces different earnings and revenue risk than other major retailers.

This article should not be relied on as a basis for investment advice and you should consult with your investment advisor before making any decisions to buy or sell securities.

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