One Stop Shops Costco and Wal-Mart Will Be Ascendant for Years

The internet may be chipping away at most retailers, even some clothing stores will lose ground. Clothing is not in any apocalyptic danger so don’t go pressing the eject button on anything. Some big box retailers will not vanish though. They will be sources of goods that are just convenient to pick up locally, or time-sensitive but hard to find elsewhere. Hard to find because of the success of big box stores and the internet.

Costco Wholesale Corp. (Nasdaq: COST) and Wal-Mart Stores Inc. (NYSE: WMT) are two stores that are becoming more and more important. At least that is my perception from just having to live in the country. It might be different in other parts of the US, but Costco is where you go for food with a long shelf life and big ticket appliances. Wal-Mart is where you go if you want items you just do not need in bulk, but would be pointless to order online. Also, you go to both for general household items like soap or dishwashing fluid. There are supermarkets, but it just depends on your overall needs. That is my experience, because I am limited in what I need. In a nearby city I see Wal-Mart crowded in the produce and frozen food section. The lines at Costco are sometimes inhuman, and that includes the line for the pizza. The scope of these stores far extends my uses of them, but I hardly think I am representative of the population.

Costco’s fundamentals are pretty good, but the margin being below 2% bothers me. Costco has a paid membership aspect so I would think that would provide a nice boost to margins, but upon further consideration membership dues are very reasonable probably pale in comparison to sales. Margin is in line with history, therefore not a red flag. However, I will keep an eye on Costco for improving margins because that would be an exceptional sign. In general paper thin margins make me uneasy, because there is a lack of cushion. Fixed costs do not decline nearly as fast as revenue when bad things happen. Companies with a healthy margin can absorb that decline while making changes. Paper thin margins mean that companies get smacked while they make changes, excuse the vernacular.

Costco has some low debt with the debt to equity ratio at 0.1104. I like that because I think Costco needs to expand into other countries. If Indian politics can work themselves out to produce something even moderately beneficial Costco would fit well there. I know the politics and economics get sticky, but I am not a mercantilist. I just think Costco is a great place with high quality goods and some very cheap gas. It also has almost $5B in cash, which is nice and comfortable in my opinion. Costco’s revenue has been increasing every year, and it is a company that has been ramping it up even with the rough economy. That really impresses me, and I think margin could improve if it really made an effort. I do not know when or if margin will improve, but revenues have been going up consistently.

I think Costco could be a long-term winner, as long as there is intelligent expansion and cost control. I read the recent earnings transcript, but it was mostly numbers that are reflected in the financial metrics. I did not see much in the way of grand strategy, but some of the explanations were interesting. If you are not familiar with foreign exchange issues it might be a good read before you delve into that research. Of note was its floor space expansion metric. Costco is all about the size of the store and what is on display. More floor space usually means more stores, and this last quarter had some of the highest growth in recent history at a 5% expansion of square footage.

Wal-Mart just drives me a bit nuts conceptually. It has almost $500B in revenue ttm, which means that the company takes in half a trillion dollars. This is not profit, but on a conceptual level it is just staggering at how much money flows through Wal-Mart. Wal-Mart also sports a better profit margin than Costco with 3.51% as the last quarter’s margin. There have been instances where that number has risen to above 4%, and seeing this consistently would be a great sign. Half a percentage point is pretty good considering the amount of revenue. Wal-Mart also boasts consistent revenue growth. Maybe it will consistently break half a trillion in revenue very soon. I focus on revenue for both companies because both have consistent margins so revenue works better for me. It allows me to take in the scale of these businesses. If margins were volatile I would just look at net income ttm. No earnings call to read yet, I hope management goes over more grand strategy than Costco.

Both retailers show impressive revenue growth, and I know both are looking overseas for expansion possibilities. The Costco earnings call discusses Mexican operations a bit. One big takeaway was that Costco completed acquisition of the other half of its operations in Mexico. That means any future expansion will go to the company completely. I am sure Wal-Mart is being just as aggressive about getting into new markets.

Both companies strike me as great investments, and I am not sure which one I would choose if I had to pick one. Under threat of bodily harm, I think Costco has more of a debt cushion to use in the case of determined expansion to capture new opportunities. That is a shaky reason to choose one over the other, because Wal-Mart is the larger company and can still muster a vast amount of leverage. I tend to favor smaller companies, because I think those companies can make strategic decisions that have a larger impact on the stock. However, that is just a personal preference and a slightly riskier path.

Note: Also on Motley Fool here.