Costco's Winning Strategy

Costco Wholesale Corporation is a big winner in the retail sector, reporting a streak of strong sales, including one this week.

For the retail month of March, the five weeks ended April 3, Costco reported net sales of $21.61 billion, an increase of 18.7% from $18.21 billion a year earlier. Excluding gasoline sales, same-store sales rose 12.2%, while online sales rose 9.2%

Costco's strong March sales shook off fears among investors that the company's performance would be negatively affected by the end of the stimulus payments. They further confirm that Costco continues to win customers offline and online, helping send its shares to new highs.

How does Costco do it? In several ways. First, Costco has managed to segregate the consumer market effectively by charging a membership fee, luring the high spenders to its stores, and sending the low spenders to low-end competitors like Walmart. Meanwhile, the membership fee generates a steady income stream for the company. It’s like printing money.

Second, the company has been very effective in managing capital, as evidenced by a steady rise in the Economic Value Added (EVA), the difference between the Return on Invested Capital (ROIC) and the Weighted Average Cost of Capital (WACC). According to estimates by Gurufocus, Costco's EVA has risen from 2% in 2010 to 9% in 2021. And things could get better as the company scales up its operations by opening new stores.

Effective capital management has allowed the company to compete on low margins and attract more customers.

"We like COST for its unwavering execution of its business model, which includes operating its stores ultra-efficiently and providing value to its customers by charging a razor-thin markup of only 14%-15%," says Quo Vadis Capital President John Zolidis, who follows the stock closely. "This strategy has enabled COST to acquire customers and grow its business for decades. Further, the company's high penetration of non-discretionary products (grocery) means that its performance is somewhat insulated from big economic swings."

Third, Costco has been successfully riding a new retailing trend: the merging of online and offline sales. Shoppers can order the merchandise online and pick it up in local stores or have it shipped to them from the local stores for same-day delivery. And that has helped traditional brick-and-mortar retailers gain a competitive edge against online retailers like Amazon.

Last year, Costco launched Costco Next (CN), a special category that includes a broad selection of curated products from some of the company's most reliable suppliers. It's designed to supplement both inventory and quality standards, upping the competition against Amazon.

In short, Costco seems to have been doing many things right to win consumers' hearts and wallets at home and abroad.

Meanwhile, its shares are an excellent defensive play in a challenging economic environment of high food and energy inflation and rising interest rates, which is to be followed by slow economic growth and possibly, a recession.

But Costco's shares aren't a bargain, according to Zolidis, who's holding on to the company’s shares. "COST shares are not cheap at current levels (a P/E of 43x FY22 EPS), but we're not selling," he says.

Editor's note: Panos Mourdoukoutas owns shares of COST.