COST - Costco

[SlowAppreciation]

Surprised there's no thread already. Maybe because it's a retailer trading for 27x earnings?

 

• 2nd largest retailer in the world
  
• ~750 warehouse-style stores (opening 25 new ones per year). Only "members" can shop there
  
• 50m very loyal members (88% retention rate), and adding ~2.5m new ones per year
  
• Makes most of their money off membership fees rather than merchandise sales. Almost all merchandise margin is reinvested into lower prices and better products
  
• First class operator (highest sales per store/employee in industry, negative working capital, high inventory turns)
  
• $135b sales / $2.7b profit / $4b FCF (all growing ~8% year)
  
• 13% GM, 3% OM, 2% NM
  
• 25% ROE, 15% ROC (and increasing since total capital has been flat while profits have increased)
  
• Great management team (and Munger on board)
  
• E-Commerce growth is accelerating—35%+ year (though off a small base and only makes up 3.7% of total sales)
  
• Has largely been unaffected by Amazon
  
• Lots of opportunities for continued growth (e-commerce, international/China, Kirkland private brand)
  
• Surprisingly little ownership from top investors. Aside from BRK's small stake, and Munger's personal stake, only Gayner and Russo hold any shares. But these positions are <0.2% of their total portfolio.
  

 

If anyone is interested in more detail, I put together a deck.

[EricSchleien]

The link to your deck doesn't work.

[SlowAppreciation]

The link to your deck doesn't work.

 

Whoops, sorry about that.

[Guest longinvestor]

Surprised there's no thread already. Maybe because it's a retailer trading for 27x earnings?

 

• 2nd largest retailer in the world
  
• ~750 warehouse-style stores (opening 25 new ones per year). Only "members" can shop there
  
• 50m very loyal members (88% retention rate), and adding ~2.5m new ones per year
  
• Makes most of their money off membership fees rather than merchandise sales. Almost all merchandise margin is reinvested into lower prices and better products
  
• First class operator (highest sales per store/employee in industry, negative working capital, high inventory turns)
  
• $135b sales / $2.7b profit / $4b FCF (all growing ~8% year)
  
• 13% GM, 3% OM, 2% NM
  
• 25% ROE, 15% ROC (and increasing since total capital has been flat while profits have increased)
  
• Great management team (and Munger on board)
  
• E-Commerce growth is accelerating—35%+ year (though off a small base and only makes up 3.7% of total sales)
  
• Has largely been unaffected by Amazon
  
• Lots of opportunities for continued growth (e-commerce, international/China, Kirkland private brand)
  
• Surprisingly little ownership from top investors. Aside from BRK's small stake, and Munger's personal stake, only Gayner and Russo hold any shares. But these positions are <0.2% of their total portfolio.
  

 

If anyone is interested in more detail, I put together a deck.

 

Thanks for posting. Nice deck too (minimalist slides are a hit with me).

 

Question? Instead of WMT, Sam's club would be an apples-to-apples comparison. I'm sure WMT does not break out Sam's Club numbers, so that would make it difficult. I'm aware that brand loyalty is far, far better at Costco, so are product brands, they are clearly premium relative to Sam's. Judging by the company I keep at Sam's versus my friends who shop at Costco, the demography is clearly lower socio-economical strata relative to Costco.

 

But Sam's club is a big hit with small business, they open the store to them earlier than consumers. The Member's mark brand is also dirt cheap. I'm a cheap shopper:-) P&G for ex. is bearing the brunt of this, judging by my own shopping behavior. Tide and Gillette for example are clearly rattled as I am seeing, they are throwing in massive discounts; There is one for $25 off of $100 purchase today. Member's mark still beats that discounted price. It's not fun to be a brand for boxed goods. One subtle yet significant change I see both at Walmart and Sam's is the display label size and actually the larger font size of the unit price (your slide # 62 on Heinz Ketchup price per OZ). As a price conscious shopper, my eyes go toward that number first and I don't have to squint or get really close to read it ;)  Plus I don't stand in line for check out anymore at Sam's with their Scan and Go app. WMT is clearly going to squeeze Amazon on margins even more.

 

And then there is Aldi! I am not a regular there, but am starting to observe their strategy as I am able to. They are yet another reason to challenge the naive assumption that Amazon dominates retail from here to judgment day. Your concluding slide is spot on!

 

 

[SlowAppreciation]

Surprised there's no thread already. Maybe because it's a retailer trading for 27x earnings?

 

• 2nd largest retailer in the world
  
• ~750 warehouse-style stores (opening 25 new ones per year). Only "members" can shop there
  
• 50m very loyal members (88% retention rate), and adding ~2.5m new ones per year
  
• Makes most of their money off membership fees rather than merchandise sales. Almost all merchandise margin is reinvested into lower prices and better products
  
• First class operator (highest sales per store/employee in industry, negative working capital, high inventory turns)
  
• $135b sales / $2.7b profit / $4b FCF (all growing ~8% year)
  
• 13% GM, 3% OM, 2% NM
  
• 25% ROE, 15% ROC (and increasing since total capital has been flat while profits have increased)
  
• Great management team (and Munger on board)
  
• E-Commerce growth is accelerating—35%+ year (though off a small base and only makes up 3.7% of total sales)
  
• Has largely been unaffected by Amazon
  
• Lots of opportunities for continued growth (e-commerce, international/China, Kirkland private brand)
  
• Surprisingly little ownership from top investors. Aside from BRK's small stake, and Munger's personal stake, only Gayner and Russo hold any shares. But these positions are <0.2% of their total portfolio.
  

 

If anyone is interested in more detail, I put together a deck.

 

Thanks for posting. Nice deck too (minimalist slides are a hit with me).

 

Question? Instead of WMT, Sam's club would be an apples-to-apples comparison. I'm sure WMT does not break out Sam's Club numbers, so that would make it difficult. I'm aware that brand loyalty is far, far better at Costco, so are product brands, they are clearly premium relative to Sam's. Judging by the company I keep at Sam's versus my friends who shop at Costco, the demography is clearly lower socio-economical strata relative to Costco.

 

But Sam's club is a big hit with small business, they open the store to them earlier than consumers. The Member's mark brand is also dirt cheap. I'm a cheap shopper:-) P&G for ex. is bearing the brunt of this, judging by my own shopping behavior. Tide and Gillette for example are clearly rattled as I am seeing, they are throwing in massive discounts; There is one for $25 off of $100 purchase today. Member's mark still beats that discounted price. It's not fun to be a brand for boxed goods. One subtle yet significant change I see both at Walmart and Sam's is the display label size and actually the larger font size of the unit price (your slide # 62 on Heinz Ketchup price per OZ). As a price conscious shopper, my eyes go toward that number first and I don't have to squint or get really close to read it ;)  Plus I don't stand in line for check out anymore at Sam's with their Scan and Go app. WMT is clearly going to squeeze Amazon on margins even more.

 

And then there is Aldi! I am not a regular there, but am starting to observe their strategy as I am able to. They are yet another reason to challenge the naive assumption that Amazon dominates retail from here to judgment day. Your concluding slide is spot on!

 

Sam's Club is definitely a closer comp versus WMT, but hard to get all the data on it. However it's pretty clear that Costco simply out-executes Sam's Club, which results in lower prices, more affluent customers, and better growth prospects

 

Your points about small biz and Sam's Club are the same for Costco (20% of their members are small biz owners).

 

Sam's Club is also closing ~60 stores, 50 of which are <25min drive to the nearest Costco.

 

I'm not too familiar with the Sam's Club store brand, but Costco's Kirkland is incredibly valuable, and it now makes up 25% of the company's total sales. And it's a product you can't find anywhere except Costco. So I agree that the CPG guys must be nervous.

 

Aldi is interesting as they seem to have a similar model to Costco, though without the massive bulk sizes and quality brands. Seems like a well run company, but I read an article the other day about their scaling back of US expansion this year. Can't find the article now, but I believe the original plan was for 60 new stores and now they're doing 30.

[Guest longinvestor]

My point is that Costco+Sam’s+Aldi+XYZ+ABC versus AMZN. Online, ship-to-home etc are no longer differentiators for Amazon. As you point out, Costco is playing with that before scaling up. So is WMT.

 

Around Chicagoland, there are some entrenched, small, local grocery chains that are next to impossible to compete against. Heck, they beat the crap out of even WMT in their niches.

 

No, retail and grocery are alive and kicking.

[Viking]

SlowAppreciation, great summary.  I used to call on Costco 20 years ago (for a large multinational). I came to understand and appreciate their business model. Very tough customer to deal with, but very predictable (they were very transparent with what they wanted from a manufacturer). Never owned the stock even I admired their business model... great example of too much thumb sucking on my part.

 

Here are some thoughts:

- the 20 foot check: regarding marketing, Costco explains to suppliers that if your pallet has great graphics/appeal your sales will increase by +20%. So manufacturers are motivated to have the right container, the right tray with graphics and the right pallet configuaration with total graphics. Costco says from 20 feet away a customer should see your pallet and be drawn to it. This creates a lot of competition among manufacturers to have the best pallet look. And it works.

- Darwinian listing model gets manufacturers aggressively competing with each other: Costco is open to listing new items as long as it will sell at a higher level than existing items; this creates an incredible amount of competition for like items (i.e. there are lots of cheese manufacturers competing for the same listing). And they are not constrained by category. As a result, manufacturers are constantly coming up with new ideas for products. Lower selling items are constantly being challenged by new potentially higher selling items. Costco tells the manufacturers of lower selling items they need to do better or lose the listings. Bottom line is Costco has a steady stream of new products fighting for listing space. This model is constantly morphing...

- Kirkland Signature: for many years, Costco was national brand focussed. However, they always said if the value gap got too large they would look to launch Kirkland Signature in that category. It will be interesting to see where they take Kirkland Signature in the coming years; perhaps it will join the national brands in terms of recognition with consumers (not sure). Launching Kirkland Signature is the nuclear option for Costco in a category. They are yelling at the national brand that their value proposition no longer works.

- treasure hunt aspect is unique: Costco does an amazing job of bringing in quirky items/seasonal items. This motivates shoppers to come into the store more frequently (to see what is new). This also motivates purchases (the item might not still be there when you go back the next time).

- return policy is best in class: crazy what they take back. Cost is picked up by manufacturer as cost of doing business with Costco

- real estate angle. My understanding is when they purchase real estate for a new location they also buy adjacent land is it all goes up in price once Costco announces they will be building.

[bizaro86]

I thought there was a thread already, I thought I remembered discussion on COST last spring/summer. I bought some then at $160 on Amazon fears. I have it in my "keep this quality business forever" mental bucket.

 

Great deck, one thing I would add is the advantage of only selling one brand of everything. You mentioned them being a big buyer because of that, but that isn't the full extent of the leverage it gives them.

 

Vendors know they only sell one brand. If you're P&G, you know you're one discount away from getting replaced by Kimberly Clark. And you won't lose 20% of the volume, you'll lose 100% of the volume.

 

[bookie71]

Munger is on the board.

When I first started following Costco they were 6th in rank.  How much farther can they go?

They closed all of the Sam's clubs in Alaska and Costco is opening it's 4th warehouse in Alaska.

As one of my best friends said, "Going to Sam's is like going to amatur hour"

[chrispy]

Great deck. I never quite understood all they did and how well they do it. Thank you guys for sharing your insights

[SlowAppreciation]

SlowAppreciation, great summary.  I used to call on Costco 20 years ago (for a large multinational). I came to understand and appreciate their business model. Very tough customer to deal with, but very predictable (they were very transparent with what they wanted from a manufacturer). Never owned the stock even I admired their business model... great example of too much thumb sucking on my part.

 

Here are some thoughts:

- the 20 foot check: regarding marketing, Costco explains to suppliers that if your pallet has great graphics/appeal your sales will increase by +20%. So manufacturers are motivated to have the right container, the right tray with graphics and the right pallet configuaration with total graphics. Costco says from 20 feet away a customer should see your pallet and be drawn to it. This creates a lot of competition among manufacturers to have the best pallet look. And it works.

- Darwinian listing model gets manufacturers aggressively competing with each other: Costco is open to listing new items as long as it will sell at a higher level than existing items; this creates an incredible amount of competition for like items (i.e. there are lots of cheese manufacturers competing for the same listing). And they are not constrained by category. As a result, manufacturers are constantly coming up with new ideas for products. Lower selling items are constantly being challenged by new potentially higher selling items. Costco tells the manufacturers of lower selling items they need to do better or lose the listings. Bottom line is Costco has a steady stream of new products fighting for listing space. This model is constantly morphing...

- Kirkland Signature: for many years, Costco was national brand focussed. However, they always said if the value gap got too large they would look to launch Kirkland Signature in that category. It will be interesting to see where they take Kirkland Signature in the coming years; perhaps it will join the national brands in terms of recognition with consumers (not sure). Launching Kirkland Signature is the nuclear option for Costco in a category. They are yelling at the national brand that their value proposition no longer works.

- treasure hunt aspect is unique: Costco does an amazing job of bringing in quirky items/seasonal items. This motivates shoppers to come into the store more frequently (to see what is new). This also motivates purchases (the item might not still be there when you go back the next time).

- return policy is best in class: crazy what they take back. Cost is picked up by manufacturer as cost of doing business with Costco

- real estate angle. My understanding is when they purchase real estate for a new location they also buy adjacent land is it all goes up in price once Costco announces they will be building.

 

These are all great points too. I think I'll have include some into the 2nd version of the deck.

 

Also, interesting re: the real estate—I'd never heard that. But then what do they do with the adjacent land? If they leased it out, income from it would certainly need to be separately disclosed in their financials. And I don't recall reading anything like that before.

[SlowAppreciation]

I thought there was a thread already, I thought I remembered discussion on COST last spring/summer. I bought some then at $160 on Amazon fears. I have it in my "keep this quality business forever" mental bucket.

 

Great deck, one thing I would add is the advantage of only selling one brand of everything. You mentioned them being a big buyer because of that, but that isn't the full extent of the leverage it gives them.

 

Vendors know they only sell one brand. If you're P&G, you know you're one discount away from getting replaced by Kimberly Clark. And you won't lose 20% of the volume, you'll lose 100% of the volume.

 

Also a good point. The interesting thing about Costco is the more you look, the more self-reinforcing advantages you find with their model. Good quote from Buffett on Munger & Costco from one of the ASM QA sessions:

 

I mean, all the time he is finding new virtues in Costco, you know, and then it — and he’s right, incidentally. I mean, Costco has an enormous appeal to its constituency. They delight — they surprise and delight their customers. And there is nothing like that in business. You have delighted customers, you’re a long way home.

 

I think there were a few posts about it, but not in a Costco-specific thread. Maybe in the "what are you buying today" thread or one about how grocery stocks reacted to the WFM acq?

 

I too bought a little on the AMZN/WFM fears around $152, and it's in the same bucket for me.

[SlowAppreciation]

I thought these were funny, and worth sharing as well:

 

CAROL LOOMIS: In a book about Charlie, “Damn Right!” by Janet Lowe, Charlie talks about his view on teaching finance.

 

He says that he would use the histories of a hundred or so companies that did something right or wrong as a basis for teaching the course.

 

Could each of you — and since this concerned Charlie, could each of you — we’ll start with Charlie — give us an example or two from either category, right moves or wrong moves?

 

WARREN BUFFETT: I predict Charlie is going to talk about Costco. Go ahead, Charlie. (Laughs)

 

CHARLIE MUNGER: Well, Costco, of course, is a — (laughter) — a business that became the best in the world in its category, and it did it with an extreme meritocracy and an extreme ethical duty, self-imposed, to take all its cost advantages as fast as it could accumulate them and pass them onto the customers. And, of course, that created ferocious customer loyalty.

 

And it’s been a wonderful business to watch, and, of course, strange things happen when you do that and do that long enough.

 

Costco has one store in Korea that will do over 400 million in sales this year. These are figures that can’t exist in retailing, but, of course, they do.

 

And so that’s an example of somebody having the right managerial system, the right personnel selection, the right ethics, the right diligence and et cetera, et cetera, et cetera. That is quite rare.

 

And if you — if once or twice in a lifetime you’re associated with such a business, you’re a very lucky person.

 

AUDIENCE MEMBER: Charlie, you’ve mentioned that, if given the chance — or the same chance with a smaller capital base — you would still look for mispriced stock opportunities.

 

CHARLIE MUNGER: Of course.

 

AUDIENCE MEMBER: And that would be determined through, obviously, what we’ve called the intrinsic value of the organization — or the company in question — an aggregate of the discounted future cash flows.

 

Would you work the arithmetic using a fictional data set to illustrate the mathematical principia to determine an intrinsic value?

 

And I hope you include the comprehensive mental model of the key metrics considered, and quantitative assessments of the management, and any assumptions of its industry to determine the durability of its earning power.

 

And, Warren, same to that effect. Would you also demonstrate or illustrate an arithmetic problem set using, with a significant capital base, and provide the object lessons on how those have changed from a small to a large capital base?

 

CHARLIE MUNGER: Well, I can’t give you a formulaic approach because I don’t use one. (Laughter)

 

And I just mix all — (laughter) — I just mix all the factors and if the gap between value and price is not attractive, I go on to something else.

 

And sometimes it’s just quantitative. For instance, when Costco was selling at about 12 or 13 times earnings, I thought that was a ridiculously low value, just because the competitive strength of the business was so great and it was so likely to keep doing better and better.

 

Well, I can’t reduce that to a formula for you. I liked the cheap real estate. I liked the competitive position. I liked the way the personnel system worked. I liked everything about it.

 

And I thought, even though it’s three times book, or whatever it was then, that it’s worth more. But that’s not a formula that anybody —

 

If you want a formula, you should go back to graduate school. (Laughter)

 

They’ll give you lots of formulas that won’t work. (Applause)

 

WARREN BUFFETT: This is the longest we’ve ever gone in a Berkshire meeting without Charlie saying that — getting to the point where he prefers Costco to Berkshire. (Laughter)

[Charlie]

I think originally Buffett thought the competitive advantages of Cosco weren't so strong and that Munger is not totally rational about Costco and that their is super strong competition in the industry. I think Buffett sold nearly all the Wal Mart shares because of the unpredictability of the industry.

That are probably the reasons Buffett didn´t invest more in Costco.

 

Buffett told the joke that Buffett and Munger are kidnapped and the terrorists ask the capitalists for their last will.

Munger said he wants to make a presentation of the virtues of Costco with all slides and all pictures.

Buffett replied: Shoot me first.

 

:)

 

 

[RadMan24]

Good stuff here. A few guys mentioned they bought after Amazon, that was indeed one opportunity to buy Costco around 24x f p/e.

 

If you go back then, Costco same store sales were getting stronger and stronger. And recently, their online sales have continued to grow 30%. Kirkland brand is just ridiculous how strong it is. For a while, people ignored these trends with the fear of Amazon and Whole Foods. Well...if anything, Costco has gotten stronger over the past year than Whole Foods, in my opinion. The lower tax rate also helped Costco fund lower prices and wage gains for their employees. Long-term this will greatly benefit the company compared to competition.

 

BJ's is going to have an IPO soon, so it will be interesting to see how well they mimic the Costco style.

 

 

[bizaro86]

The thread from the time of the Amazon/Whole Foods sell-off is here: http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/costco-selloff/

 

I had thought I contributed, but upon re-read apparently all I did was buy the stock and think nice thoughts about it. Sorry about that.

[Spekulatius]

The thread from the time of the Amazon/Whole Foods sell-off is here: http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/costco-selloff/

 

I had thought I contributed, but upon re-read apparently all I did was buy the stock and think nice thoughts about it. Sorry about that.

 

LOL, that exactly what one should do. It takes less time to push the buy button than to make 20 posts and then do nothing.

[sys]

they're not surprising and delighting me lately - based on their decision to only stock an organic version of some of the fruits and vegetables that they used to sell non-organic versions of for half the cost of the organic.  i'm going to costco maybe half as much as i used to.  if i have to go somewhere else for reasonably priced fruit anyways, then it's too much of a hassle to fight the lines at costco.

[fareastwarriors]

they're not surprising and delighting me lately - based on their decision to only stock an organic version of some of the fruits and vegetables that they used to sell non-organic versions of for half the cost of the organic.  i'm going to costco maybe half as much as i used to.  if i have to go somewhere else for reasonably priced fruit anyways, then it's too much of a hassle to fight the lines at costco.

 

I agree with you on the first part. Give me both options dam it! And yet, the lines continue to be long...

 

[bizaro86]

I've always found their produce expensive, and sized too large for me to use before it goes bad.

 

My shopping tip for costco is to buy things that have high margins elsewhere.

 

Milk, fruit, and soda are competitive (where I live) so costco low margins aren't a big price advantage.

 

But meat, cheese, flowers, and pharmacy/otc/personal care items are high margin goods where costco is WAY cheaper.

 

[Charlie]

Aldi (also the owner of Traders Joe) and Lidl, probably the most successful companies in Germany, are entering the US market. Buffett also mentioned it recently. Tesco got killed by them.... So it´s not easy to say, which company will survive.

If I had to bet I would be on Costco´s side because of Munger and the great business model, but not at a PE of nearly 30.

[rb]

Aldi and Lidl are not really competitors for Costco. They play in different pools.

[Charlie]

rb, they play in different pools, because Aldi and LIDL sell mostly food and have small stores!?

 

I can think of some similarities:

- They sell from the palette.

- First Aldi sold a lot of private labels. They didn't sell Coca-Cola. A few years back they changed that.

- Aldi and LIDL have a very limited number of products, but very good ones.

- Aldi and LIDL are super efficient.

- A few years back there was no marketing for Aldi and LIDL. They changed that.

 

Some years ago Wal Mart entered the german market, lost some money and left the market, probably because of too strong competition.

There are some legendary stories about the Aldi brothers in relation to thrift. It´s a culture of thrift and avoidance of envy (like Berkshire).

 

It´s also interesting from the standpoint that brands could get more powerful again (e. g. Kraft Heinz) if the retail landscape changes....

 

 

[Value418]

Is anyone else surprised by how much square footage Costco sets aside for clothing?  Of all their efficiencies, I have always wondered why.  Not referring to underwear, socks and gloves as much as shorts, shirts, pants, etc.

[rb]

rb, they play in different pools, because Aldi and LIDL sell mostly food and have small stores!?

 

I can think of some similarities:

- They sell from the palette.

- First Aldi sold a lot of private labels. They didn't sell Coca-Cola. A few years back they changed that.

- Aldi and LIDL have a very limited number of products, but very good ones.

- Aldi and LIDL are super efficient.

- A few years back there was no marketing for Aldi and LIDL. They changed that.

 

Some years ago Wal Mart entered the german market, lost some money and left the market, probably because of too strong competition.

There are some legendary stories about the Aldi brothers in relation to thrift. It´s a culture of thrift and avoidance of envy (like Berkshire).

 

It´s also interesting from the standpoint that brands could get more powerful again (e. g. Kraft Heinz) if the retail landscape changes....

No, they play in different pools because they address different parts of the market. Costco shopper tends to be affluent. Lots of them are small business owners. Costco sells higher end, more expensive products. Aldi/Lidl on the other hand target lower income folks and stock cheaper, lower end stuff.

 

The average/target customer of Aldi/Lidl would have trouble shopping at Costco.