Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Grocery Wars

Amazon and Other Threats to Costco

There’s good news at Costco Wholesale (NASDAQ: COST) revenue growth at the iconic club store is holding steady. That indicates Costco is holding its own against Amazon (NASDAQ: AMZN).

Costco’s revenues grew by $880 million during the third quarter of 2016, which is pretty good. The wholesale club started the quarter with $118.72 billion in August and finished with $119.6 billion in November. That indicates Costco is growing and should clear the $120 billion in revenue mark this quarter.

More importantly revenue growth actually accelerated a little in third quarter. Costco added $780 million in revenues during the second quarter. It started with $117.94 billion in revenue in May and finished with $118.72 billion in August.

This indicates that Costco is growing steadily and avoiding the dismal situation at Target (NYSE TGT) where revenues fell by $1.117 billion during the third quarter. Target reported $71.6 billion in revenues in July and $70.43 billion in October ouch.

Is Costco Amazon Proof?

The revenues raise the intriguing question is Costco Amazon-proof? The answer is maybe, Costco, might be able to hold off Amazon with its good shopping experience, cult like following and ability to deep discount.

One obvious conclusion we can make here is that Costco has a far wider moat against Amazon than more traditional retailers like Target. Costco’s unique business gives it some protection that two of its biggest rivals Target and Walmart lack.

From a revenue perspective Costco is doing much better than Walmart (NYSE: WMT), which has far more resources to play with. Walmart’s revenues grew by $770 billon during the third quarter which is less than Costco’s. Walmart reported $483.83 billion in revenues in July and $484.60 billion October.

To be fair, Walmart has expenses Costco lacks including money losing overseas operations; particularly in Brazil, and massive investments in online infrastructure. Yet it is still growing and positioning itself to threaten Costco.

Walmart’s Threat to Costco

Yet Walmart is not losing money, it seems to have protection against Amazon. One reason why might be that Walmart is becoming more like Costco. Walmart operates Costco’s biggest direct competitor; Sam’s Club, it is also copying some of Costco’s business model. now offers Shipping Pass which provides free two day shipping for $50 a year. Over the summer, it acquired an online shopping service that’s a lot like Costco. Jet offers very low prices and free shipping, it was originally a subscription service but that was dropped.

All this indicates that Walmart is becoming as big or bigger a threat to Costco as Amazon. One reason for that is Walmart; like Amazon, is a very hungry company that’s always in search of revenue. The corporate culture at Walmart is designed to seek more revenue aggressively. Since Costco is one of the biggest revenue generators around, both Amazon and Walmart try to copy it.

The problem Costco faces here is that it is uniqueness is threatened by Amazon and Walmart. Both Amazon and Walmart are offering membership clubs with the added twist of the convenience of online shopping. Why drive to Costco and push a cart around when you can sit down at the tablet, smartphone or the computer and order what you need?

The ultimate threat Walmart poses to Costco is two tiered; first it can undercut Costco’s prices and second it can offer a far more convenient shopping experience. This can take the form of delivery or the various order pickup options it is experimenting with. Amazon is so afraid of Walmart’s pickup experiments that it is experimenting with its own pickup location in Seattle.

A more long term threat is Walmart’s experiments with delivery via Uber and Lyft which might make cheap same day delivery easily scalable. Walmart is experimenting with Uber delivery in Phoenix and Lyft delivery in Denver. The company is also experimenting with Sam’s Club same day delivery via Deliv in Miami.

My take is that Costco is Amazon proof; at least for now, but it is not Walmart proof. The company’s unique business model can survive an assault by Amazon as it now stands, but not an all-out attack by Walmart which appears to be developing.

Why Walmart wants to be Costco

Walmart would like to be more like Costco for one simple reason: cash. Costco is a very cash-rich company, it reported a net income of $2.41 billion on November 30, 2016.

That figure was complemented by $3.292 billion in cash from operations and $6.116 billion in cash and short-term investments. The cash and short-term investments number exceeded Walmart’s which was $5.939 billion on October 31, 2016.

Costco manages to keep more cash than Walmart even though its resources are smaller. Walmart reported a cash from operations figure of $32.30 billion on October 31, 2016.

More importantly Costco managed to accumulate more cash even though its net income is smaller than Walmart’s $14.46 billion. Another reason why Walmart wants to be more like Costco is that its net income has dropped in recent years, falling from $17.2 billion in October 2013 to $14.46 billion in October of this year.

Obviously, Walmart’s operations are far more complex than Costco’s. Costco only operates one type of store, while Walmart operates several kinds of stores and a large online operation. Walmart also reported $206.86 billion in assets compared to $36.53 billion for Costco.

All this verifies Costco’s business model by showing it has a tremendous amount of float for a retailer. Although that does not make Costco a value investment because I think it is overpriced at $160.63 a share (that was the price on December 16, 2016).

Is Costco a Good Investment?

Despite its price Costco can be considered an income investment. COST rewarded investors with a return on equity of 21.03% on November 30, 2016.

Costco shareholders also took home a dividend of 45¢ on November 2, 2016. That is up from 40¢ in April 2015, To add icing to the cake, Costco has paid out a super dividend on occasion, the last one was $5 on February 5, 2015. Before that COST paid a $7 ultra-dividend on December 6, 2012.

If that was not enough Costco’s normal dividend has increased by 15.5¢ over the past three years. It rose from 27.5¢ to 31¢ to 35¢ to 45¢, in 2014, 2015, and 2016.

All that  shows that Costco may not be Amazon proof but it is a great dividend stock. Although I would wait until Costco’s share price to fall to buy it because it is currently overpriced.