The Race for Retail Supremacy, Part 2
- By Shudeep Chandrasekhar
In the first part of this two-part series, I covered the world's two biggest retailers - one on the brick-and-mortar side of the business and the other on the online side. Although Wal-Mart and Amazon (WMT) (AMZN) are undoubtedly in competition for the same market, there were subtle differences that I discussed in the first article.
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The intrinsic value of COST
In this piece, let's look the next crop of retailers that are near or above the $100 billion per annum sales mark.
Costco
If you are already a member of Costco (COST), it is tough for any other company to lure you away from them. Their consistently-above-90% membership renewal rate stands testimony to that strength. The huge customer base Costco patiently built has long allowed the company to rely on membership fee revenue for its profits while keeping the cost of goods sold at lowest possible levels.
The bigger that base grows, the more it benefits its customers because it gives Costco even more leverage with its suppliers and vendors. In fact, it is what feeds back even more customers into the membership program.
Furthermore, the company has always kept its pitch simple, making it easy for users to see the benefits that they can derive by staying on as members. If there is one company that can stand strong against Amazon twenty years from now it will be Costco Wholesale.
Why do I say this? First of all, despite the growth of e-commerce and its encroachment on brick and mortar retailers, neither Costco's membership growth nor its renewal rates have been affected. Second, if you remove the effect of oil prices on their comps you will see that they are actually growing faster than the competition.
But that is not the only reason. The surprising thing is that their members are not clamoring for online access. Costco is taking its own time figuring out the online space, doing tests in the UK and getting some of the best technology behind it. But if they wait too long, they are going to lose the opportunity to bring in new customers when they finally do go online. Wal-Mart and every other big box retailer is pushing the e-commerce angle now, not waiting for later. Costco must get in soon if it wants to see any meaningful gains.
Other than that it is hard to find any major problems with the way Costco operates. If they can keep on doing what they have been doing for the past 33 years - and get moving on the e-commerce front - then it is safe to say they will be around for a few more decades.
Kroger
The best thing about Kroger (KR) is that it has mastered the art of bringing multiple supercenter brands under a single roof. What typically happens is that newly acquired brands will undergo a rebranding exercise to bring it in line with the parent brand, but not at Kroger. The strategy they follow is to nurture new brands by bringing them all together in one location, a strategy that has paid off so far.
That is one of the reasons the Kroger you see on the West Coast will never be the same as anywhere else. And that is also the reason why they are not growing their stores at a rapid pace. There are large pockets in the United States that Kroger has not even begun to cover. Florida, for example, has a grand total of one Kroger supermarket, while California has over 340.
But it is this disparity that gives Kroger the ample room for growth within the United States.
As for sustainability, Kroger has been pushing up its grocery contribution to overall revenue and that figure currently stands at 23.4%. Groceries and perishables are the biggest moat that physical retailers have against companies like Amazon. The latter is trying to get into that space with its Prime Now service in a few cities across the U.S., but Amazon will never be about large scale grocery deliveries. They will find their place, for sure, but it will be a nominal share of market.
Expansion and depth is what Kroger needs for the future. They have got a sustainable business model, but I will only be happy recommending the stock when that starts to happen. Otherwise, we can expect them to stay relatively flat for the foreseeable future.
Target
Target (TGT) seems to be the weakest link in the brick-and-mortar chain in the United States. The company's revenues have slowed down during the last few years and the company says that it expects to face a challenging environment for the rest of this year as well.
The company's ambitious international expansion plan came to a screeching halt as they made a hasty retreat from Canada, but that is just one of the challenges it is currently up against. Their biggest challenge - as well as opportunity - lies in how wisely they invest in the online space.
They are already an easy target for e-tailers to take customers away and that is what has been eating away at the top line at Target. If the company can push harder on the e-commerce front, it may well be able to recover whatever it has lost over the past years. At least it will give them a measure of sustainability into the future.
As things stand, Target is the one retailer that has me wondering whether they can stay the course. Yes, they have been able to slowly move their stock upwards, but things look extremely volatile even on a longer time scale.
A Final Note
The five companies I have covered in this and the previous article practically rule the retail space in the United States. But aside from Amazon, none of them have a significant presence outside the United States that can match or even ably support domestic revenues. I believe this is where the real opportunity is for brick and mortar retailers - not to carry their exact business model and stuff it down the throats of new countries, but take their skills overseas and blend them with local talent that can help build their presence there from scratch.
Amazon had three years in India and has already become the number one e-commerce portal in the country. Wal-Mart, on the other hand, could not even get a foot in the door - and they have been trying for much longer than that.
So why is it that Amazon can go into a new country and do business without ruffling too many local feathers, while brick and mortar retailers behave like bulls in a China shop? If they can answer that question, I think these retailers can grow even faster, wider and deeper across the globe than they have ever been able to in the past.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
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This article first appeared on GuruFocus.
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The intrinsic value of COST
