Costco’s Mall Strategy Could Boost Stock by 3%

The Wall Street Journal recently reported that Costco (NASDAQ:COST) is capitalizing on the dire U.S. real estate market by snapping up vacant space in shopping malls. Costco competes with Wal-Mart (NYSE:WMT) and others in the U.S. retail market.

From the point of view of mall owners, Costco is thus assuming the anchor tenant role that has historically been filled mainly by department stores. This marks a departure from the usual big box strategy of building stand-alone stores in open spaces rather than enclosed malls.

This strategy could benefit Costco in the form of increased store count and reduced capital expenditures. If that scenario pans out, we forecast a modest 3% upside to our $49.76 stock price estimate for Costco. Our analysis follows below.

Mall strategy may help in urban expansion

Shopping malls could be a viable alternative for Costco in urban markets where land is scarce and expensive. Moreover, mall locations impose fewer burdens on retailers in terms of setting up infrastructure and dealing with community opposition to warehouse-size stores.

We currently expect Costco’s U.S. store count to reach 480 by the end of our forecast period, up from 408 at the end of 2009.  However, we think Costco’s mall strategy could allow it to open an additional four to five stores each year in the U.S. over the duration of our forecast period, yielding a potential upside of more than 3% to our price estimate.

You can drag the trend-line in the chart below to create your own U.S. store growth forecast for Costco and see how it impacts the company’s estimated share value.

Buyers’ market

Shopping mall vacancy rates are currently hovering around 11% in the U.S., according to Reuters. In the second quarter of 2010, retailers vacated some 1.85 million square feet of occupied mall space. Mall owners are courting Costco and other big box retailers as replacement tenants. As a result, Costco and its peers should be able to negotiate favorable lease terms.

Although rent payments could boost Costco’s operating expenses, we would expect a rising proportion of mall stores to reduce its capital expenditures. We think the overall impact could be positive, adding to the 3% potential upside discussed above.

You can see the complete $49.76 Trefis price estimate for Costco’s stock here.