Costco Is A Better Bet Than Walmart

Walmart stock (NYSE: WMT) has grown by close to 16% since early February after the WHO declared the Coronavirus a global health emergency, while Costco stock (NASDAQ: COST) has gained about 12% of its value. Both big-box retailers have benefited from the increased essentials sale during the lockdown period. In fact, both of these companies have a wide variety of inventory, omnichannel capabilities, and discounted prices. However, we believe Costco will likely fare better than Walmart because of its unique business model based on membership fees. Costco collects fees from its members and sells items in bulk at rock-bottom prices while making most of its operating margin from these membership fees. This is despite the fact that these fees account for only 2% of the company’s total revenues. Moreover, it passes on cost savings to consumers by eliminating overhead costs like a salesperson and ornamental buildings (a business model oddly well-suited to the current economic times). Although Walmart’s Sam’s Club competes directly with Costco in wholesale retailing, this segment accounts for only 12% of Walmart’s total revenues.

We discuss more in our detailed dashboard analysis, ‘Costco Looks Better Than Walmart’ wherein we compare trends in key metrics for the two large discount retailers over the years to determine their relative valuations under the current circumstances. We summarize parts of this analysis below.

Why Costco?

Costco has seen better revenue and earnings growth over the last 5 years compared to Walmart. Costco’s 2014-19 annualized revenue growth of 6.3% is 3.9x that of Walmart’s growth rate of 1.6%. Also, Costco’s annualized EPS growth during the same period of 12% was much higher than Walmart’s -14%. In addition, Costco’s P/E based on 2019 earnings has grown from over 35x in 2019 to 41x currently, while Walmart’s multiple is expensive compared to Costco and has grown from 52x to about 58x. The steeper growth in multiples can be attributed to the coronavirus crisis that has accelerated the sales of groceries. 

Both companies seem richly valued and investors will only pay for quality and growth amid the uncertainty surrounding the pandemic. As it is, both companies demonstrate those qualities and will likely outperform the broader market over the long run. But Costco edges out Walmart on its membership program, loyalty, the opportunity for store growth, and high sales. Costco’s loyal customer base has a renewal rate of 90%, and so long as it can retain customers, it will continue to have a strong business. Loyalty increased during the pandemic when Costco put the safety of employees and customers first, requiring social distancing and masks ahead of other retailers. Costco has 15 new store openings planned for the next few months. The wholesale retailer is also investing in e-commerce, an area it’s lagged in, with its March acquisition of Innovel Solutions, which specializes in last-mile delivery for big and bulky products.

Walmart’s e-commerce sales expanded during the pandemic, surging 74% in fiscal Q1 ended May 1. The retailer’s revenue grew 9% year-over-year (y-o-y) to $135 billion in Q1. Its U.S. same-store sales surged 10% y-o-y. On the other hand, Costco’s net sales increased 7% to $37 billion in fiscal Q3 (ended May 10). Its same-store sales for the quarter increased by 4.8%, and e-commerce sales jumped 64.5%. In addition, its paid membership increased by 2.7 million year-over-year to 55.8 million. It should also be noted that Costco’s revenue in July jumped 14.1% from the prior-year period, and e-commerce sales catapulted 75.3%. The company posted similar growth metrics in May and June, showcasing how recession-proof the business is during the current scenario.

But How Long Will The Market Remain Under Pressure?

The expected timeline for recovery in global economic conditions hinges on the broader containment of the coronavirus spread. Our dashboard forecasting US Covid-19 cases with cross-country comparisons analyzes expected recovery time-frames and possible spread of the virus.

Further, our dashboard -28% Coronavirus crash vs. 4 Historic crashes builds a complete macro picture and complements our analyses of the coronavirus outbreak’s impact on a diverse set of Costco’s multinational peers. The complete set of coronavirus impact and timing analyses is available here.

We believe there will be a recovery in demand for most sectors by late September or early October, with the gradual lifting of lockdowns and a gradual rise in the number of Covid-19 cases remaining within the manageable capacity of hospitals and care providers. Although most companies are reporting poor Q2 results, market expectations will be buoyed by a visible improvement in the situation on the ground.

Overall, we believe Costco stock price at levels of $337 provides a buying opportunity for investors willing to be patient.

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