• Home
  • About
  • Team
  • Contacts
  • Blog

Costco Moat

  1. Home
  2. Blog
  3. Costco Moat

Client Letter August 2001

I like retail stocks because it is an easy business to understand. It is fiercely competitive business with thin margins, but it is predictable under certain circumstances. Once a company establishes a sustainable competitive advantage it can last for a long time (Wal-Mart in the eighties, Home Depot in the early nineties, Costco and Nebraska Furniture Mart today).

The most recent 10 Q for Costco shows their gross margin (net sales minus merchandise costs) as 10.37%. For me this is a remarkable figure, and is the heart of their competitive advantage. Basically this statistic measures how much the retailer marks up his merchandise before he sells it to the public.

On the surface a low margin would appear to be bad. You would think that the retailer with the lowest margins would make the least money, in fact this simple ratio is a good way to measure a retail moat.

Costco’s margin

Store Gross Margin Net profits Return on equity
Wal-Mart 23.0% 3.2% 19.0%
Costco 10.4% 1.7% 14.9%
Dillard’s 32.3% 1.7% 4.5%
Best Buy 20.5% 2.6% 21.0%
Home Depot 31.4% 5.6% 17.2%
Albertson’s 31.2% 2.4% 15.3%
Bed Bath and Beyond 43.0% 7.3% 20.0%

In other words Costco can show the same profit on 10.4% markup as Dillard’s can on a mark up of 32.3%. For a watch that manufactures sells for $100. Dillard’s would have to sell it for $132.30 to make the same profit that Costco would make by selling the same piece for $110.40 (this percentage is actually based on a markdown not a markup so the real prices would be higher, but you get the idea.) Wal-Mart is bringing 1.5% more down to the bottom line so they would price the watch at $124.5 ($123 + $1.50).

Or if you want to buy a barbecue grill that the manufacturer sells for $200, you can go to Wal-Mart and pay $249.00 or Home Depot and pay $274.00; or you can buy it at Costco and pay $220.80. Again the math is approximate. Also I suspect that the Home Depot markup varies by product lines and barbecues probably do not get marked up as much as a can of paint.

How can Costco sell the same product cheaper that other big box retailers? Part of the answer is that they are really fussy about turnover. They only stock stuff that they can sell fast. Costco turns their inventory 12.8 times a year whereas Dullard’s turn is 5.3, Bed bath and Beyond is 4.7, Home Deport is 6.7, and Wal-Mart is 9.1.

Obviously you do not have to mark merchandise up as much, if you are turning it faster than anyone else. Assuming your other costs are the same as your competitor if your turn is twice as fast you only need half the markup to get to the same bottom line.

Fast turnover has another big advantage; most retailers pay their suppliers in thirty days so if you can turn your inventory 12 times a year your suppliers pay you to carry their product. This keeps expansion cost low because you do not have a big investment when it comes to inventory. You can see on Costco’s Balance sheet that their inventory is $2.6 Billion while Receivable are $2.5 Billion. In other words the suppliers pay for their inventory.

Another Way to keep your costs down is to have a big box, if you have a big store and a lot of turns you end up with a lot of volume per store.

Costco’s Balance sheet

Store Total Sales (Billions) No. of stores Sales Per Store (Millions) Inventory (Billions) Turns
Wal-Mart $191.3 4190 $45.7 $21.4 9.1
Home Depot $45.7 1129 $40.5 $6.6 6.9
Albertson’s $36.7 2500 $14.7 $3.3 11.1
Costco $32.1 313 $102.6 $2.6 12.8
Best Buy $15.4 400 $38.5 $1.7 8.5
Dillard’s $8.6 337 $25.5 $1.6 5.3
Bed Bath and Beyond $2.9 311 $9.3 $.6 4.7

That’s right Costco’s per store sales are 2.5 times that of home depot, and 4 times that of Dillard’s. Comparing it to Wal-Mart is a bit of Apples Vs Oranges because Wal-Mart’s figures include 495 Sam’s Clubs and 888 Supercenters. I have read that Sam’s volume per store is about half of Costco’s. I do not know how reliable these figures are but if anyone has good information on this I would like to hear it.

Table Two above to shows two of the reasons that Costco can sell cheaper than other stores (faster turnover and More sales per store). Another factor is the membership fee. Costco will collect over $600 Million in Member fees this year a figure that is greater than its total net after tax income.

There are many other factors that contribute to Costco’s competitive advantage, many of them have been mentioned on this board before. When you add them all up it amounts to a huge Moat. They can sell Computers cheaper than Best Buy, towels and sheets cheaper than Bed Bath and Beyond, power tools cheaper than Home Depot, Bananas cheaper than Albertson’s and trash cheaper than Wal-Mart. With this pricing power they have the ability to cherry-pick from any retail category and sell only the highest volume products from across the complete spectrum of retail products.

There are two competitors in their field, but BJ’s with $4.9 billion in Sales and 118 stores is only doing about 41.5 million per stores. It is only generating cash flow to build 14 stores this year compared to Costco’s 35. Sam’s Club’s threat is harder to evaluate, but for the last four years Wal-Mart has slowed the expansion of Sam’s to a crawl While doubling the number of Supercenters to from 44 to 88. A policy that indicates to me they do not feel competing with Costco is the best use of their capital.

Today Costco reminds me of Home Depot when I first bought into it (1990). At the time HD had about 150 stores, but they had a lower gross margin than their competition, and they already established their dominance in their niche. All they had to do to be a huge winner was to keep doing what they had been doing over an over again for the next ten years. Nothing complicated, no restructuring, no new management, no technical revolutions, Just the same thing day after day year after year. Very boring.

Other than Berkshire, I do not see much today that I feel I can hold for the long haul, but Costco may one exception. I expect Costco will be in our Portfolios for a long time.

08/01/2001



Leave a Reply Cancel Reply

Your email address will not be published.


Comment


Name

Email

Url


Blog Archive

2020

  • The Stock Market

2019

  • Behavioral Investing

2018

  • Trumped
  • Warren Buffett vs Wall Street
  • Globalism, 1982-2000 Bull Market

2017

  • Volatility Underlying Calm Market
  • What’s new with CB&I?
  • Passive Investing
  • Economic Cycles
  • Current Stock Market 2017 Comment

2016

  • Global Plastics Summit Highlights
  • Value Investing vs Index Investing
  • How to Play an Index Bubble
  • Successful Investors
  • Is the Market Overvalued?
  • Operating Earnings
  • Article by investment manager in Bay Hill Living
  • Building Foundation

2015

  • 3G Culture – Dream Big
  • Myopic Loss Aversion
  • CBI Nuclear Energy
  • St Joe Company
  • What’s in a Word? Plastics.
  • Are Bonds Safer Than Stocks?

2014

  • Chicago Bridge and Iron
  • CAMEX 2014
  • Global Economy October 2014
  • Fluor Corporation
  • Interesting Quotes from Daily Journal Annual Meeting
  • The Daily Journal Annual Meeting
  • Albemarle Corporation
  • Triumph Group
  • The American Energy Revolution
  • Singapore

2013

  • St Joe Company Update
  • Hedge Fund Managers
  • Triumph Group Inc.
  • Bitter Brew
  • An Antifragile Portfolio

2012

  • Leucadia National Corporation
  • This Time it is Different
  • Successful traders psychology
  • St Joe Company
  • Learning from Pain

2011

  • Long Cycles – Part II
  • Long Cycle
  • Nasty Month for Market
  • Make a Buck with Fortescue Metals Group
  • Berkshire Hathaway Look Through Earnings
  • St Joe Company Inc
  • Successful Investment Management
  • A Look Into Latin American Market
  • The Mother of all Quarters
  • 2010 Investment year results

2010

  • Fault Lines
  • US Market 2010
  • Berkshire Hathaway Third Quarter 2010
  • The Stock Market 2010
  • Berkshire Hathaway Second Quarter 2010
  • Berkshire Hathaway Performance
  • Long Term Greedy
  • Goldman Sachs
  • Berkadia and Leucadia
  • USG corporation
  • Berkshire Hathaway 2009 2010
  • Why Capitalism Works

2009

  • The Lords of Finance
  • The $44 Billion Dollar Train Set
  • Berkshire Hathaway 3rd Quarter 2009
  • Career Risk for Investment Manager
  • Berkshire Hathaway financial statements
  • Berkshire Hathaway Preferred Stock
  • Moral Hazard
  • Credit Default Swap
  • The Shadow Banking System
  • Learning Things the Hard Way
  • Our C-System
  • 2008 Investment results

2008

  • Investment Risk
  • Bear Markets
  • Generational Events
  • Orange sheets – Money is doing better
  • Inflation Not The Problem
  • Tipping Point
  • Long Term Capital Management
  • Financial Insurance
  • Western Refining Inc
  • Berkshire Hathaway Year To Date
  • Berkshire Hathaway Cash Flow
  • 2007 investment results

2007

  • Investment results 4th Quarter 2007
  • Greenspan on Inflation
  • Berkshire Hathaway Third Quarter 2007
  • Berkshire Hathaway Operating income 2007
  • Berkshire Hathaway Hedge Fund
  • Leveraged Buyouts
  • Stability Unstable
  • Weak Dollar
  • Berkshire Hathaway Chairman’s Letter
  • Steel Dynamics
  • Breakwater Resources
  • 2006 Investment year results

2006

  • New Investment Stocks
  • Equitas
  • Berkshire Hathaway Third Quarter 2006
  • Hurricane Synergy
  • Berkshire Hathaway Second Quarter 2006
  • Fat Pitch
  • Perfectly Obvious
  • Berkshire Hathaway Growth Rate
  • Berkshire Hathaway First Quarter 2006
  • Berkshire Hathaway Annual Report 2006
  • Inflation Is
  • 2005 Investment year results

2005

  • Exogenous Events
  • The Easy Money
  • Look-Through Earnings
  • High-Risk Mortgages
  • Unintended Consequences
  • Rydex Ursa Fund
  • Warren Buffett Premium
  • Private Equity
  • Latticework Mental Models
  • Buffett’s Lackluster Performance
  • 2004 Investment year results
  • Professor Smith’s Second Bubble

2004

  • Hedging Currency Disaster
  • Risk Assessment
  • Too Many Bears
  • The Chinese Century?
  • Patterned Irrationality
  • Timber
  • Costco’s Cash
  • Physics Envy by Charlie Munger
  • Asset Allocation Berkshire Hathaway
  • The Balance of Payments
  • 2003 Investment year results

2003

  • Hedge Funds
  • The trade deficit is not debt
  • Secular Bear Market
  • Which Index Funds?
  • A Different Drummer
  • Costco’s Float
  • The Power of Float
  • Berkshire Hathaway Annual Meeting 2003
  • Psychology of Human Misjudgment
  • Sitting on the Sidelines
  • Berkshire Hathaway intrinsic value
  • 2002 Investment year results

2002

  • Insurance company Moats
  • Bond Bubble
  • Berkshire Hathaway Cash Flow 2002
  • Behavioral Economics
  • The Bear Market 2002
  • Greenspan Put
  • Second Quarter Cash Flow at Berkshire Hathaway
  • Berkshire Hathaway Annual Meeting 2002
  • Red Wire – Green Wire
  • Stupid FED Tricks
  • The Bottom Line
  • 2001 Investment year results

2001

  • Don’t Fight the FED
  • Buy and Hold? – It all Depends
  • Ben Laden and Berkshire Hathaway
  • The Dinosaurs Dance
  • Costco Moat
  • Bubble Watching
  • Sit on your Ass investing
  • Berkshire Hathaway Annual Meeting 2001
  • Carnival Cruise Lines
  • 450000 Square Ft Furniture Store
  • Lunch Money Indicators – Annual report
  • Other People’s Money

2000

  • Bear Tracks
  • Build It and Money Will Come
  • Efficient Stock Market
  • Style Drift
  • Lunch Money Indicators – Options
  • Identifying Problems
  • Small Retail Stocks
  • Charlie Munger comments
  • Big Al and the Bubble Machine
  • Berkshire Hathaway Cheap
  • Index Funds
  • 16 rules for investment success
Make an appointment or contact us by phone: +1 (689) 246 49 49
© 1999 - 2022 Losch Management Company
Support by Global AGM