Consumer stock wins despite low online awareness

Costco’s low gross margin membership-only-warehouse-club model is still working fine, says BMO Capital Markets analyst Kelly Bania. And awareness of its online presence among Costco members, while currently disappointingly low, gives ample opportunity for this consumer goods stock’s growth in a fast-changing environment.

Upon surveying U.S. consumer goods stock Costco Wholesale Corporation (NASDAQ—COST)  members in December 2016, New York-based BMO Capital Markets analyst Kelly Bania gained a deeper understanding of its members’ perceptions. The analyst was also able to gauge potential trends, and evaluate competitive risks.

Following the survey, the analyst confirms that Costco remains a top pick. She reiterates her ‘outperform’ rating and $180 target share price. The target price is based on 13 to 14 times enterprise value over earnings before interest, taxes, depreciation and amortization on BMO’s fiscal 2018 forecast.

Low on-line awareness for a consumer services stock

As the analyst sees it, a big opportunity for Costco lies in raising the company’s online profile and presence, which as of yet has low awareness. In the survey conducted, 35 per cent of Costco members were not aware that Costco offered online services.

This was a surprisingly large percentage in the analyst’s view given that 60 per cent of the respondents are also Amazon Prime members and 10 per cent are using online grocery and delivery services. “We believe online, which is higher margin for Costco, remains a large opportunity, particularly as Costco continues to enhance its online offering.”

Price perception relative to Amazon is negative for Costco. “Based on our survey results, 60 per cent of respondents were also members of Amazon Prime. Despite our survey work that shows that Costco’s prices are meaningfully lower than Amazon’s, 61 per cent of those Amazon Prime members thought that Amazon and Costco prices were ‘about the same’.”

Loyalty high but bulk-buying declining

On a positive note, Costco’s membership loyalty appears high. Despite the high crossover with Amazon Prime members, only four per cent of those surveyed believe that Amazon Prime completely replaces the need for a Costco membership, and those respondents skew younger. Additionally, only 13 per cent said they would be “not likely at all” to renew their membership if Costco raised membership fees by 10 per cent.

The lack of awareness of Costco’s online presence, as noted by the analyst, is not as big a risk as expected. The lack of demand for buying in bulk is a bigger headwind.

The respondents who do not buy in bulk skew to a younger age bracket, and of the respondents that cited a decrease in frequency over the last six months, the reason why was overwhelmingly (38 per cent of respondents) because they ‘buy less in bulk’.

Significantly less, at eight per cent of the respondents, were those that found ‘more convenience online’.

“Long term, Costco’s low gross margin philosophy, combined with product nimbleness and growing convenience support our outlook for Costco to remain highly relevant in a fast-changing consumer environment,” said the BMO analyst.

 

This is an edited version of an article that was originally published for subscribers in the  March 10, 2017,  issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.

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