How long can the Costco Money Machine Survive?

Costco Wholesale (NASDAQ: COST) could be the most profitable retailer in the universe.

For instance, Statista reported quarterly revenues of $37.04 billion from 782 stores on 30 November 2019. In contrast, Walmart (NYSE: WMT) reported quarterly revenues of $127.991 billion from 11,766 stores worldwide on 31 October 2019.

In fact, Costco claims to have 60 warehouses that exceeded $250 million in annual sales, Investopedia reports. Additionally, Costco claims to have two warehouses that generate annual sales of $400 million.  

Moreover, Investopedia estimates that the average U.S. Costco store had $160 million in annual sales in 2018. Conversely, Statista estimates the average Costco store worldwide had $176 million in annual sales.

Is Costco Making Less Money?

Despite its success, Costco could make less money. To explain, Costco reported a quarterly gross profit of $4.807 billion on 30 November 2019. However, that that quarterly gross profit is down from $6.188 billion on 31 August 2019.

Additionally, Costco’s quarterly revenues fell from $47.498 billion on 31 August 2019 to $37.04 billion on 30 November 2019. In addition, Costco’s quarterly common net income fell from $1.097 billion on 31 August 2019 to $844 million on 30 November 2019.

However, Costco Wholesale’s operating income fell from $1.463 billion on 31 August 2019 to $1.081 billion on 30 November 2019. Plus, Costco’s operating cash flow fell from $2.293 billion on 31 August 2019 to $2.102 billion on 30 November 2019.

However, Costco’s ending cash rose from $1.371 billion on 31 August 2019 to $9.027 billion on 30 November 2019. Thus, Costco Wholesale is generating more cash even though it is making less money. In addition, Costco’s ending cash went from $6.778 billion on 30 November 2018 to $9.027 billion on 30 November 2019.

Jeff Bezos’ Costco Killer: Amazon Prime

Amazon Prime is the greatest threat to Costco Wholesale’s survival. To explain, Costco makes money by locking in customer loyalty by selling subscriptions and offering low prices.

The subscription obligates customers to shop at Costco because they pay for it. Costco rewards subscription holders with low prices.

Prime uses the same business model; subscription and low prices, and adds the conveniences of shop-from-home, and free two-day delivery. Hence, I think Jeff Bezos designed Prime as a Costco killer.

In fact, author Brad Stone claims Bezos got the idea for Prime’s membership system from Costco cofounder Jim Sinegal. Specifically, Sinegal explained Costco’s membership system to Bezos over a cup of coffee in 2001, Stone writes in Chapter Four of The Everything Store: Jeff Bezos and the Age of Amazon.

“The membership fee is a one-time pain, but it’s reinforced every time customers walk in and see forty-seven-inch televisions that are two hundred dollars less than anyplace else,” Jim Sinegal supposedly said. “It reinforces the value of the concept. Customers know they will find really cheap stuff at Costco.”

Thus, people shop on Amazon because they find cheap stuff there. Additionally, Amazon (NASDAQ: AMZN) customers need to justify the money they spend on Prime by shopping at The Everything Store.

Amazon Prime vs. Costco

Amazon claims Prime attracted over five million new members during the 2019 Holiday season, Quartz reports.

However, a large percentage of those new Amazon customers began free trials of Prime. I think many of those customers will let the Prime membership lapse after they complete their holiday shopping.

Prime is expanding with free food delivery from Whole Foods and Amazon Fresh, USA Today reports. The two-hour service could be available over 2,000 American communities.

Statista estimates Amazon Prime had 105 million U.S. subscribers in June 2019. In contrast, Statista estimates Costco had 94.3 million members worldwide in 2018.

Consequently, Amazon Prime’s membership ecosystem in one country (the USA) was larger than the entire Costco membership system. Given those numbers, I have to wonder if Costco could compete with Amazon Prime.

Amazon, for instance, could make enough money from subscriptions to undercut Costco’s prices with deep discounting. Plus, Amazon could have obligated 105 million Americans to shop at Prime.

Is Costco a Value Investment?

Mr. Market grossly overvalued Costco (NASADAQ: COST) at $291.20 a share on 6 January 2020. Therefore, I think Costco is far from a value investment.

However, I believe Costco is still a great income and dividend stock at any price. In fact, Costco paid a 65₵ dividend on 31 October 2019.

Overall, each Costco share offered a 0.89% dividend yield, an annualized payout of $2.60, and a payout ratio of 31.75% on 6 January 2020. Additionally, Dividend.com credits Costco Wholesale with 15 years of dividend growth.

In the final analysis, I consider Costco Wholesale a good stock you will make money from. However, Costco faces a death match with Amazon Prime that could destroy its business.

I advise people not to buy Costco because Mr. Market overprices it. However, Costco is still a good stock to hold because of its great dividends.