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Questor: Costco – 30pc cheaper than Amazon and sustainably profitable. Buy

Shopping trolley graphic
Shopping trolley graphic
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Fantasy Fund Manager - Article Puff - no sponsor

Any retailer that can withstand competition from Walmart, Amazon, Lidl and Aldi is worth a second look. Costco Wholesale, founded in 1976, has not just held its own against these formidable rivals but prospered throughout.

You might not think that operating from vast no-frills warehouses far from the high street and charging customers for the privilege of crossing the threshold would cut it in an age when you can order anything from your phone and get it the next day.

But Costco’s modus operandi, which includes charging a membership fee, brings unique advantages both to it and to its customers, according to one long-standing investor.

Its ability to sell high-quality products at low prices is at the heart of Costco’s appeal. “By comparison with Amazon and conventional retailers it sells a far smaller range of products – 3,000 against 12m for Amazon,” said Michael Crawford of Chawton Global Investors.

This gives Costco huge negotiating leverage with its suppliers because it allows them to maximise their economies of scale. Costco is also growing more quickly than many of its key suppliers, so its buying power is increasing.

We could say that the retailer lives up to the “pile it high and sell it cheap” mantra quite literally: it leaves its products on pallets in its stores because this saves the cost of putting them on shelves. Customers often buy in bulk, perhaps stocking up for a month at a time.

“Amazon will struggle to compete for this kind of business because it’s more efficient for a customer to drive to a Costco, load his car and drive everything home than to run a warehouse, employ people to pick and pack orders and operate a delivery fleet to get those orders to customers’ homes,” Mr Crawford said.

“From my own experience shopping at Costco I can say that some of its products are 30pc cheaper than Amazon’s.”

Costco key facts
Costco key facts

Costco’s warehouses have turned out to have other advantages that have helped it to trade well through the pandemic. “Their sheer size and wide aisles make social distancing easier, while the membership model may encourage more disciplined behaviour on the part of customers,” Mr Crawford added.

“And the firm sets great store by treating its staff well – it pays them about double the going rate. As a result they are motivated not only to offer good service in normal times but to police coronavirus rules. This no doubt reassures shoppers generally that it’s a safe place to visit.”

He praised the company’s strong culture, which involved not just looking after shop-floor staff but bringing managers up through the ranks, a “culture of frugality” and careful allocation of capital.

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Costco has spread internationally from its roots in America but does so one step at a time. “It will set up one store in a country and see how it goes and how it needs to be adapted,” said Mr Crawford.

“It started in Anglo-Saxon countries but the formula is working well in Asia, especially in Japan and Korea. If the first few shops in a new country don’t work it will stick with them but not build more, as in Spain and France.”

This measured approach has led to returns on capital of at least 14pc and average annual sales growth of 7.5pc over the past five years. Profits tend to grow at about the same rate.

Such performance normally attracts a high valuation and so it is with Costco. But, as we have often said, a business that can sustain high returns on capital can make money for investors even if they pay a high multiple of earnings. “The shares have risen more than fivefold in 10 years,” Mr Crawford said, “even though they have always looked expensive.”

One cloud on the horizon is the possibility of tax rises in America under Joe Biden. “But Costco said the tax rate hadn’t affected its plans on the way down [under Donald Trump] and it didn’t expect it to affect them on the way up,” Mr Crawford said.

Questor says: buy

Ticker: Nasdaq: COST

Share price at 7.30pm: $387

Read the latest Questor column on every Sunday, Tuesday, Wednesday, Thursday and Friday from 6am.

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Get in touch | How to contact Questor