The past 5 years have been very challenging for retailers. Most of them had to pay the consequences of missing the e-commerce revolution. Some of them, like giant Wal-Mart Stores, Inc. (NYSE:WMT), are trying to catch up as fast as possible, but revenue growth is still not happening.
A clear exception is Costco Wholesale Corporation (NASDAQ:COST), which recently reported growth of 7% in net sales for July. Costco Wholesale Corporation (NASDAQ:COST)’s growth figures are hard to believe in an industry that gets surprised when Wal-Mart Stores, Inc. (NYSE:WMT) manages to keep comparable-store sales growth in the 2% range. But what is driving Costco’s revenue growth? When will it stop? And does Costco Wholesale Corporation (NASDAQ:COST) represent an interesting investment opportunity given the current stock price?
Founded in Seattle in 1983, Costco Wholesale Corporation (NASDAQ:COST) is the third largest retailer in the US and the seventh largest retailer in the world, with 632 warehouses, including 451 in the US and 85 in Canada.
Unlike Wal-Mart Stores, Inc. (NYSE:WMT), Costco uses a membership-only system. In other words, you have to be a Costco member or a member’s guest to buy there. As of February 2013[update], Costco had 68.2 million members.
At first glance, this practice looks harmful for revenue growth, because a potential customer needs to pay at least $55 per year for membership. However, the membership-only system is a competitive advantage.
4 reasons to be a bull
1. Low risk, high return
Just like J.C. Penney Company, Inc. (NYSE:JCP) or Wal-Mart Stores, Inc. (NYSE:WMT), Costco’s revenue is highly exposed to macroeconomic cycles. However, by using a membership-only system, Costco is able to book nearly all of its profits one year in advance. R.J. Hottovy from Morningstar states that membership revenue actually accounts for nearly all of Costco’s operating profits.
How big is the membership effect? Assuming that each of Costco Wholesale Corporation (NASDAQ:COST)’s 68.2 million members has the cheapest membership package ($55 per year), that’s about $3.751 billion just from memberships secured 12 months in advance! Despite the increasing membership fee, the number of new members has increased substantially from 2.3 million in 2009 to 4 million in 2011.
2. Consistently profitable
Unlike J.C. Penney Company, Inc. (NYSE:JCP), Costco has been consistently profitable for several years. More recently, in the third quarter Costco’s operating income was up $100 million, or 16% from the same period last year.
3. International expansion
Costco Wholesale Corporation (NASDAQ:COST)’s international expansion has just begun, but results are very promising so far. It operates 170 international warehouses, which make roughly 50% of total revenue. This proportion is significantly bigger than Wal-Mart Stores, Inc. (NYSE:WMT)’s international revenue. Furthermore, considering that 170 international stores make as much as Costco’s 451 U.S. stores, we can infer that the average revenue for each of Costco’s international warehouses is much higher.
By owning more than 80% of the properties where it operates, Costco’s return on net assets (RONA) for operations outside of North America is roughly 12%, well above the company’s cost of capital. In contrast, Wal-Mart’s RONA range for international operations over the last 10 years is 6%-7%.
Asia is a key market for Costco. The company has seen 20,000 to 60,000 membership signups on the opening day of Asian stores. That’s why the opening of 7 Asian warehouses this quarter could accelerate the company’s current growth rate.
4. High EPS, safe dividend and increasing share repurchases
Since 2007, Costco’s diluted quarterly EPS has grown 73%, well above Wal-Mart Stores, Inc. (NYSE:WMT)’s 29% and J.C. Penney Company, Inc. (NYSE:JCP)’s -380%. At this pace, analysts estimate that Costco’s EPS will reach $5.05 by 2014.
Costco’s dividend has also grown steadily since 2004. The current yield is just 1.11%, but it is worth keeping in mind that for the past 4 years, Costco’s payout ratio did not change much.
Finally, the company actively repurchases shares. Between 2003 and 2012, Costco’s total number of outstanding shares dropped by 40 million.