Costco: risks and long term analysis

Costco: Risks and Long Term Analysis

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Costco (NASDAQ: COST) includes large stores and warehouses with domestic appliances, consumer electronics, clothes, and books. Besides, Costco chain includes gas stations, tire shops, and other services. It is not only a food&beverages company. This is why, even though Food&Bev sector is doing good, this won't mean Costco will be prospering.

It is important to understand how Costco gets its profits and how it manages the competition against Amazon, Walmart, and Sam’s Club. Amazon is reducing shipping costs, Walmart is developing its infrastructure, which makes Costco's position quite shaky. Costco has a very good retention model, though: with some of the lowest prices in the industry, the company also sells member cards which provide additional discount. The company's priority is analyzing the food product demand, as those who buy foods from Costco are also active in other sectors.

So, why would the customers buy wholesale, especially when the best before date is quite near? The research showed most Costco's customers have large families, and that is why they are interested in wholesale. 80% young single people tend to create families, and this will lead them to Costco (35% of the customers are between 18 and 29). Those who already have big families may lose family members due to divorce or accident, but even in this case the customer gets used to the store and continues using it. If the parents buy everything in Costco, their children are likely to do the same, and this way the customer base not only doesn't decline, but even grows.

Will crisis hit Costco?

Another thing is saving up. During any crisis, every single cent counts, and this may lead people to Costco as well. Even now, however, when there's no crisis, Costco customer base is over 94.30M people.

Costco stores are in 11 countries, with the population totaling 846M, and this may increase to 906M by 2020. This way, Costco may increase its customer base by 7% only due to the population growth. Overall, the company has 762 stores throughout the world, with 527 being in the US, which yields 80% of total profits. The population growth in the US will guarantee revenue growth for Costco.

Costco membership costs $60 per year. Every customer will have to buy a lot to make this cost effective, which makes this business model quite competitive and allows the company to even beat the online stores. Meanwhile, Costco also started selling goods online, and offers free shipping once the minimum purchase amount is achieved. Large queues in Costco warehouses also show that the customers are interested in this store chain; this, in its turn, attracts suppliers that want their goods delivered to Costco. The competition among the suppliers makes them lower the margin, which gets compensated with the increased sales. The retail markup is usually 25%, while Costco made it 14% in order to get more customers. This allows the company to offer some of the lowest prices.

Struggle for clients

Thus, Food&Beverages is a sector used by Costco for attracting new customers. Stagnation in this sector is only possible in case the population decreases, or people in all countries go on a diet, which is very much unlikely. On the other hand, food oversupply may be a negative factor for the producers, but Costco is not a producer.

Besides, Costco also won because some of its competition were having issues.

For instance, Sears Holdings Corporation, which owned Kmart and Sears, got bankrupt in October 2018. Meanwhile, Sam’s Club, Costco's major competitor, converted 63 of their stores into distributing points. All this was positive for Costco and boosted its revenues. The management is also doing good, which means the only risk lies in the competition. However, the company is winning against the competitors currently, thanks to the low prices.

Costco stocks price analysis

As for the stock price, there is some risk here. Costco's P/E is 29.44, and while this means the company is somewhat underpriced, the average P/E is much lower, 18.75. In this case, Walmart stock is much more attractive, with the P/E at 19.88. However, one should understand that once the sector gets a boost, Costco will take the lead.

The long term fundamentals show that Costco is a good investment. Both the news and the financial indicators may not always be right, though, as they are all based on the past data. It often happens when a stock has great fundamentals, but still loses its value just because the investors are booking profits. This is why investor sentiment and behavior is very much important. The chart shows the price is likely to correct to $180, with the P/E going down to reach the average or even beyond. Still, if the price manages to stay above $220, this will mean the investors are ready to take risk and buy even at this high price. If this happens, one should think about adding this stock to their portfolio.

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