Who doesn’t love Costco? Even Charlie Munger, vice-chairman of the world’s greatest compounding machine, Berkshire Hathaway, is a fan of Costco.
At Costco, we can get items in bulk at rock-bottom prices, saving us hundreds if not thousands of dollars over the years. Items like apparels, electronics, furniture, jewelry, poultry, pet supplies, gas for your car — you name it, they’ve got it.
Business Model
Costco Wholesale operates membership warehouses. As March 2022, there are Costco 828 warehouses worldwide.
To gain access to deals in Costco’s 140,000-square foot warehouses, you will need to purchase an annual Costco membership. They have two tiers of membership – a basic and executive plan for consumers/businesses, which cost $60 and $120 respectively.
Each member is entitled to issue a free supplementary card to a member living in the same household or to a fellow staff working in the same company. In 2021, Costco reported in their annual filings to have a total of 61.7 million paid members and 111.6 million cardholders.
Since 2010, the number of paid memberships has grown from 31.6 million to 61.7 million. Renewal rates are consistently above 89% in the U.S. and Canada, and 85% worldwide, giving Costco a steady source of recurring revenue. The rest of its revenue comes from its merchandise, which brought in $192 billion in 2021.
Overall, Costco’s revenue, including the sale of merchandise, has more than doubled from $78.0 billion in 2010 to $195.9 billion in 2021.
Dividend Profile
Since 2010, Costco’s dividend has been increasing at a CAGR of 13.37%, which is decent. Excluding a special dividend of $10 per share paid out last year, Costco averages a dividend payout ratio of about 25% every year.
With its predictable earnings and steady growth, we expect to seeing a dividend growth CAGR of about 10-12% for the next 5 years.
Business Risks
Naturally, the biggest risk is the threat of e-commerce players like Amazon. According to Business Insider, Costco beats Amazon 80% of the time when they compared prices of 100 items across four areas: household staples, baby and pet, beauty and toiletries, and health between the two retailers. So far, e-commerce is not a threat to Costco. It’s going to be a challenge to turn a profit for e-tailers to ship bulky goods and sell them cheaper than Costco. At the same time, investors need to be watchful as Amazon has the scale, money, and resources to directly price compete with Costco if they choose to.
Costco has also openly acknowledged that their business depends heavily on their ability to purchase quality merchandise in sufficient quantities at competitive prices. As the quantities they require continue to grow, they have no assurances of continued supply, appropriate pricing or any contract terms by the suppliers. This may be experienced with the recent supply chain shortages and the impact of the Russia-Ukraine war, which has also disrupted the price of commodities.
Final Thoughts
Costco is a low-cost leader in an industry that is largely resistant to economic recessions. In fact, people are more likely to shop at Costco when they need to tighten their purse strings! Costco’s membership revenue also gives you a predictable stream of recurring income and sets a sizable floor to the company’s revenue.
At the same time, the threat of e-commerce cannot be dismissed. But as long as Costco is able to offer some of the lowest prices that one can find for consumer staples and essential services, it’s hard to beat what Costco has to offer for the cost-conscious shoppers.