Costco’s unique value proposition
Costco is one of the best retailers in the world. Based in Seattle, USA, Costco operates 749 membership warehouses worldwide. The company offers a unique customer proposition that is difficult to replicate: by paying an annual fee of $60, customers have access to a select set of high-quality, branded products at the lowest prices. Costco differentiates itself by leveraging on its huge purchasing scale and focused merchandising team. Particularly, Costco’s merchandising team concentrates on only 3,800 Stock Keeping Units (SKUs) that are evolving over time. As a result, Costco can get the best purchasing terms from suppliers and pass on the lowest prices to consumers. While Costco’s product categories are not as diverse as other retailers, the company curates an attractive mix of branded and private-label products on a rotating basis. Costco uses excellent fresh food offerings to help generate regular customer traffic. Once customers enter Costco stores, they are in a treasure hunt looking for the latest deals. Making this business model successful requires excellent execution. Costco operates very efficiently with an inventory turnover of nearly 12 times a year on average. This allows Costco to be profitable at a competitive gross margin of 11.3%. Meanwhile, it earns a recurring profit from membership fees which provide a level of certainty for its earnings. Costco secures high membership renewal rates of 90% in the US and Canada and 87% on a worldwide basis.
Identifying growth opportunities
While Costco was founded in 1983, it still has substantial growth opportunities both within and outside of the US. Based on our analysis, Costco has the potential to open 200 additional stores in the US over the long term. Moreover, the company is still underpenetrated in Asia. Management is very methodical and disciplined when opening new stores. It has recently announced it will open the first warehouse club in Shanghai, China in 2019. After many Western grocery retailers rushed into China and suffered from their big bets, Costco prefers to enter China more slowly and thoughtfully to ensure they can generate good returns on investments.
A strong commitment to human capital
Having a good business model and strategy is not enough. What truly makes Costco an excellent company is its employees. The Costco’s CEO, Craig Jelinek, values his workforce and attributes the company’s success to its happier work environment.
Based on our discussions with management and our proprietary research, we learned that Costco has a very transparent pay scale. It offers employees premium compensation and company-sponsored health insurance. Furthermore, Costco gives its staff a purpose: every employee participates in weekly meetings in which they can discuss what they think about the company, its strategies and its results. Employees are also crossed-trained for various positions. Importantly, Costco offers a long-term career path for employees because it has a strong internal promotion policy which encourages employees to grow within the organization. Hence, Costco’s staff are willing to stay and contribute to the company for a long time. This allows Costco to safeguard its human capital which is considered an important moat for the company.
To build our conviction on Costco, our Global Analyst/Portfolio Manager has recently traveled to Costco’s headquarter in Seattle to meet with their management. She was impressed by the management’s long-term visions and its enthusiastic workforce.
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 The data is as of May 13, 2018. Costco operates 519 warehouses in the US and Puerto Rico, 98 in Canada, 38 in Mexico, 28 in United Kingdom, 26 in Japan, 14 in Korea, 13 in Taiwan, 9 in Australia, 2 in Spain, 1 in Iceland and 1 in France.
 The $60 annual fee is for the basic Goldstar member.
 The gross margin excludes membership fees.
 The figures are based on Costco’s 10Q filings on May 13, 2018.