Tags: Costco | strategy | economy | COST

Costco Strategy Comes into Focus as Economy Has Slowed

By    |   Tuesday, 05 June 2012 12:09 PM EDT

Costco (COST), unlike most retail operations, has built its model around providing only what people are likely to buy quickly or in volumes that make up for its discounting practices. As the economy has slowed, the warehouse discount strategy has come into focus as the go-to source for both consumers and small business supply needs.

Costco and its subsidiaries are principally engaged in the operation of membership warehouses in the United States, Canada, the United Kingdom, Japan, Australia, through majority-owned subsidiaries in Taiwan and Korea, and a 50 percent-owned joint venture in Mexico.

Costco operates membership warehouses based on the concept that offering members low prices on a limited selection of nationally branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover, management said in a recent filing.

This turnover, when combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, enables the retailer to operate profitably at significantly lower gross margins than traditional wholesalers, mass merchandisers, supermarkets, and supercenters, Costco said.

“Because of our high sales volume and rapid inventory turnover, we generally sell inventory before we are required to pay many of our merchandise vendors, even though we take advantage of early payment discounts when available,” management explained.

“To the extent that sales increase and inventory turnover becomes more rapid, a greater percentage of inventory is financed through payment terms provided by suppliers rather than by our working capital.”

The typical warehouse format averages approximately 143,000 square feet; newer units tend to be slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory.

Costo limits its lines to fast-selling categories, carrying an average of approximately 3,600 active stock keeping units (SKUs) per warehouse in its core warehouse business, as opposed to 45,000 to 140,000 SKUs or more at discount retailers, supermarkets, and supercenters, Costco explained.

Costco has a market cap of $37.56 billion in a sector, food and staples retailing, where the average company size is $7.76 billion. Its trailing 12-month P/E ratio is 24.11 and its five-year projected price-to-earnings-growth (PEG) ratio is 1.90, compared to 1.89 for the sector.

Its projected earnings per share growth for the coming year is 12.69 percent, compared to a sector average of 10.83 percent.

Sluggish recovery

Analysts are generally positive on Costco shares, with buy or outperform calls from Ned Davis Research, William Blair & Company, Piper Jaffray and Columbine Capital Services. B.P. Bernstein rates the stock at underperform.

“We believe that Costco is well positioned to weather the sluggish recovery in the economy given its focus on low prices,” say Zacks Investment Research analysts, who rate the stock neutral. “Besides, it would also maintain its growth momentum as evident from its monthly sales results.”

Costco next reports on Oct. 3.

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Tuesday, 05 June 2012 12:09 PM
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