Costco’s Biggest Mistake in 2016
2016 is shaping up to be the worst year for Costco Wholesale (NASDAQ: COST) stock since the recession. As of December 2, the stock is down 6% year-to-date as growth has slowed and the stock’s valuation has increased. Between 2009 and 2015, the stock more than tripled, but the bullish streak seems to be coming to an end as the retail landscape changes.
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In its fiscal year ended in September, the retailer said revenue increased 2% to $116.1 billion, while earnings per share increased to $1.77 from $1.73 a year earlier as growth was challenged by foreign currency exchange and lower gas prices. For the full year, comparable sales were up 4% globally when excluding the change in gas prices and currency. In the U.S., they increased 3%.
While Costco’s underlying performance remains solid, its growth is slowing, and there’s a clear reason why. Competition from the e-commerce channel from Amazon.com and others has been increasing rapidly, and Costco has struggled to adapt.
Fear of disruption
Costco’s biggest mistake in 2016 has been an unwillingness to adapt to the changing retail model. The company needs to find a way to keep pace with e-commerce and omnichannel advances that its competitors are making or it will fall behind the competition.
Costco sells goods online, listing electronics prominently on its website, but the online channel doesn’t fit its buy-in-bulk warehouse model, which enables it to offer rock-bottom prices in its stores. The company has also been reluctant to introduce now-standard practices such as buy-online, pick-up-in-store.
CFO Richard Galanti knows this is a conundrum. In an earnings call earlier this year, he said, “Everybody in the world never wanting to leave their house and only typing stuff to order and get it at the front door” is a growing concern for the company. But Galanti still believes the company’s biggest strength is its store-based model, adding, “We want to do everything possible to get them in the store and not just come and pick something up.” Costco benefits in part from the “treasure hunt” model, where customers pick up unique items that are temporarily available as they go through the aisles, and the retailer is afraid of losing out on those sales with a program like in-store pick-up.
The competition is moving fast
While Costco is debating the best approach to e-commerce, its competitors are acting fast. Amazon continues to open dozens of warehouses a year to accelerate shipping times. Its Prime membership program may now be Costco’s closest competitor, as Prime offers a number of perks including free two-day shipping for a $99 annual fee. There is significant overlap between Prime and Costco members, but that could change if consumers find themselves shopping on Amazon more than Costco.
Wal-Mart (NYSE: WMT) has also been rapidly expanding its grocery pick-up program, with plans to have about 1,000 kiosks in store parking lots by the end of next year. Management has said the program has been very popular. The company also acquired Jet.com for $3.3 billion to advance its own e-commerce operations.
In addition, Kroger has implemented a similar click-and-collect grocery program that allows customers to order on their phones and pick up in groceries in a store parking lot.
Costco could implement a similar program if it wanted to. It may be difficult with bulk goods, but the retailer could charge an extra fee if it found it to be uneconomical to offer for free. However, it seems reluctant to make such a move.
For now, Costco’s model is still working. Sales are growing steadily, and the company plans to open a new crop of stores in 2017 after adding 29 in fiscal 2016. Membership grew by about 7% last year, and management also said it believes mid-tier cities are a riper market that it had earlier believed.
But as e-commerce options improve, Costco’s value proposition is likely to weaken. If sales growth continues to decelerate, Costco’s lack of initiative on e-commerce will go down as its biggest mistake this year.
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