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Jefferies upgrades Costco ‘buy’ as 'leadership moat widens’

Jefferies upgraded shares of Costco to ‘buy’ from ‘hold’, citing a number of factors including increasing member loyalty and the company’s digital transformation. The firm also raised its price target for the wholesaler to $435 from $321. Jefferies analyst Stephanie Wissink joins The Final Round to discuss.

Video Transcript

SEANA SMITH: Welcome back to “The Final Round.” Let’s get to our call of the day. Jefferies upgrading Costco to buy, raising its price target to $435 a share from $321 And for more on this, we have the analyst behind the call, Stephanie Wissink. Stephanie, great to have you on the show.

Let’s just drill down into this call because it’s pretty interesting. One of the main reasons for your upgrade has been what you call this moat. You’re saying that Costco’s moat in club retail is widening at this point. What do you mean by that, and how significant do you think this is?

STEPHANIE WISSINK: Yeah, I think this is actually quite significant. We believe that the club channel is gaining share from other channels of retail. And there are a number of displaced consumers today that are seeking new destinations for their shopping. And so we think club is a gainer in this.

And when we look at Costco specifically, we think they’re gaining share with the category, but they’re also gaining share within it. And their leadership moat continues to widen. Their comp store sales significantly outindexed their peers. Their unit growth continues.

And we do think there’s an interesting phase that we’re entering now regarding omnichannel. Clearly, the club channel underindexes other retail. It’s only about 7% or 8% of their businesses online today. And we think that’s really a function of letting others test and invest, picking the best, and then ultimately deploying it inside their ecosystem.

So that’s followers versus technology leaders. But it certainly provides an additional level of inherent upside as we look ahead over the next three to five years.

BRIAN CHEUNG: Hey, Stephanie, Brian Cheung here. So what about that outlook is baked into the baskets broadening, which you described in your note? What was interesting is that it appears based off of a survey I think you guys did last year that millennials and Gen Z are actually pivoting away from some of those food categories that people tend to go to Costco for.

Oh, I don’t know. One example was that I know Costco launched a golf bag that sold out very quickly this year, so that could be one of those categories. How important are those types of things for Costco in that medium term outlook?

STEPHANIE WISSINK: Yeah, it’s incredibly important. You raise a really interesting case study in this. And that is, Costco’s permission to be more than a grocer. And we think this is really core to the thesis.

As they gain more customers and those customers shop more categories, and frankly, more quickly, within their overall membership base, they’re really signaling– the consumer is signaling to Costco that they have the permission to widen out into some of these great viral products, like a golf bag.

But I think it’s also, to us, as we think about the financial value of that, it means that beyond the membership fee income of this business that we love, because it’s a recurring stream of revenue, you’re also getting a bigger basket driver to the comp. So not just more members, but more members spending more at Costco.

And if you’ve been to a Costco recently, you’re probably seeing bigger shopping baskets. And that’s clearly showing up in their comp rate. So in order to really underwrite incremental value for the stock, we think that incremental basket size is a key component to that, beyond food and basic sundries, but really into some of these other classifications, and a golf bag being a great example of that.

DAN ROBERTS: Stephanie, Dan Roberts here. To zoom out a little bit and look at brick and mortar retail, I know Costco is a different kind of business as these other examples. But we’ve talked a lot about the huge e-commerce surges that Walmart and Target, and even Urban Outfitters and Best Buy, have all seen during the pandemic. Dick’s Sporting Goods as well.

And of course, you know, it’s obvious. It was inevitable. It had started even before the pandemic. But we also hear a lot about how BOPUS, Buy Online, Pick Up in Store, curbside pickup, have all accelerated dramatically because of the pandemic.

I guess, does it all add up to a future where you think a lot fewer people are going to be going to Costco and to other stores in person? Because of course, your bullishness on Costco is also based on digital. Is e-commerce about to just totally pull ahead in this race and leave going to physical stores in person in the dust?

STEPHANIE WISSINK: Yeah, I think it’s a very fair question. You know, we do know that this channel massively underindexes broader retail. So we’ve put broader retail in that kind of mid teens penetration going into COVID. It’s certainly well above that now. And I think we’re seeing some evidence of permanence and the shift from bricks to clicks.

At the same time, Costco has continued to benefit from traffic in its stores. So there’s something consciously that the consumer is saying, I feel safe in that space. Now maybe it’s the 15-foot aisles and the ability to explore within this multi 100,000 foot experience.

However, I do think it’s also related to the merchandise that Costco sells today is still part of that weekly or monthly venture to stock up. And I don’t know that that’s going to change per se, but we are intrigued by their ability to graduate into new categories, to build out that basket, to start to explore some of the e-commerce and omnichannel initiatives that some of these other companies have been benefiting from.

We’re not at the point yet– certainly not seeing it in our survey where the consumers are calling for it. But I think the companies are starting– the club companies, in particular, are starting to test some things to see what that responsiveness is around Buy Online Pick Up in Store. You can do that for certain categories within Costco.

You can’t do it within foods yet, but we’re watching to see, as the consumers start to call on Costco to be able to buy my groceries online and pick them up at curbside. Not yet, but possible in the future. But I think the other categories of merchandise that we’ve talked about before as being basket enhancers and value enhancers, those are things that are more likely to be omnichannel for Costco and their consumer.

SEANA SMITH: Stephanie, how does no stimulus play into all this? Because we don’t have a deal right now. Savings and households are dwindling. Is this something that’s a big headwind for Costco? Or do they have more of a higher income customer base so they’re more insulated from this type of risk, at least in the short term?

STEPHANIE WISSINK: Yeah, I would agree that in the short term, I think they’re far more insulated. And even in our survey, we found 20% of people were willing to pay upwards of $10 more for their membership every year. A membership today is about $120 at the premium level.

So a high single digit increase in pricing was not going to display 20% of the core consumer base. So I think there’s an income profile that’s more attractive, a bit more resilient overall during macro downturns. I do think the macro downturn we’ve seen thus far in the year has been more blue collar versus white collar. And they certainly do target a white collar consumer.

And then I think, in addition to that, we’re seeing their basket value is enhancing, and so the consumer trip consolidating at Costco. So they’re gaining more dollars of an existing wallet.

INES FERRE: I had a question about the variety of products when it comes to each category. Because when I think of Costco, I think of a company which concentrates its buying power really on a smaller number of items, SKUs, compared to, for example, Walmart or Target.

And also that warehouse format– and you were just mentioning earlier that people still like to go into Costco. They feel safe there. But the warehouse format seems to really help with as far as not having to transport items so much.

So did any of that go into your analysis? And if the company is moving more and more digitally as well, would they be able to expand on SKUs offering, offering different varieties of a product?

STEPHANIE WISSINK: Yeah, actually, this is a really interesting concept. Because for the last decade or so in retail, it’s really been about choice and about the power of the number of choices that you can offer the consumer and kind of giving that consumer this wide range of selection. We’re starting to see a little bit of a pivot, I think, in consumer logic. The fact that a lot of choice and a lot of dynamism is, frankly, overwhelming, and in some cases, exhausting.

So I think there’s a little bit of a power to the curation that Costco also does. It’s not something we’ve studied a lot. But I think it’s something that we’re definitely intrigued by, this idea that instead of having 17 different versions of peanut butter, they have two. And it takes away the stress of choice and the consternation of choice and makes it very simple.

So I think there’s an elegance and simplicity that we’re really starting to think about from a consumer attitude perspective. But you’re also right. As you move online, you have the ability to test a wider selection to see if that actually does drive more propensity to purchase.

And right now, within the Costco experience, I do think simplicity is an advantage. But in an online environment, we’ve seen choice and utility become a bigger advantage. So I’m curious to see how they explore that and extrapolate that. But they may be able to translate that idea of curation, simplicity–

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