2 Reasons Costco Wholesale Corporation Stock Could Fall

By Markets Fool.com

Costco (NASDAQ: COST) sales have been essentially flat year to date.

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For the 52-week fiscal year which closed Aug. 28, the warehouse club reported net sales of $116.1 billion, a 2% increase from the $113.7 billion reported last year. Those numbers aren't awful, but they hint at weakness.

When it comes to comparable sales, the numbers weren't great either, though they look better after adjusting for falling gas prices and foreign currency exchange. After the adjustment, the increase in the United States jumps from 2% to 3% and the Canada numbers go from a 3% decline to an 8% gain. International numbers were similar, moving from a 3% dip before adjustment to a 4% positive move after. Still, overall, before the adjustment, 52-week growth was 0%, and after it was only a 4% gain.

Those are mediocre results, which point to three things that could hurt Costco's stock price going forward.

Costco's business model has been to drive people to its stores. Image source: author.

Competitors are getting better

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As a warehouse club, the Costco model is built on offering great prices but limited selection. In the past, that made other warehouse clubs such as Wal-Mart's (NYSE: WMT) Sam's Club its only real competition. Now, however, the chain increasingly has to deal with traditional stores offering aggressive pricing.

Wal-Mart specifically has committed to spending billions to lower prices. That's a big problem for Costco, because the traditional retailer's deals don't require buying food in specific large quantities.

If a regular grocery store will sell a box of cereal at a price close to what Costco charges, but the warehouse club requires buying two extra-large boxes, it's easy to see why consumers may shy away from bulk purchases. That's not a big problem if it simply costs Costco some sales, but it becomes a much bigger issue if consumers stop believing Costco consistently has the best deal.

If that happens, people will drop their memberships -- and fees from people paying their annual dues accounts for 75% of the chain's profits. Essentially it's OK if consumers go to the warehouse club less, as long as they still see the value of remaining members. It's possible that more aggressive traditional stores will tip the balance in favor of people who drop their membership.

Amazon makes everything easy

Costco has mostly ignored the Internet because it's built its business around driving people to its stores. That makes sense because once people hit a warehouse, they can be enticed into buying things they'd not planned on. In addition, part of the Costco mystique revolves around bargain hunting in its stores.

That's generally been a strong formula. People join Costco partly because it's fun to shop in the stores even when you don't buy anything. Add that to the fact that prices are generally below other options (albeit with the hassle of having to buy in bulk), and you can see why the chain has thrived.

Amazon.com (NASDAQ: AMZN) has already taken away one of those advantages. It has comparable, and in some cases lower, prices than the warehouse club chain. It also has improved delivery to the point that it can get pretty much anything to consumers in two days or less.

What Amazon hasn't equaled is the experience of exploring a Costco store. It's still fun to walk into one of the chain's locations and discover that you really need a kayak or a palette of K-Cups. Online retail has struggled to equal that experience, but Amazon has gotten better at it with its flash sales and Prime Day, which had a bit of the unknown that Costco does so well turning into sales.

Should Costco shareholders worry?

The big concern is that these two problems have been evident for a long time and management hasn't done much to address them. Price competition has been a reality since Amazon became a major player, and it's doing a better job getting consumers to buy more than they intended to or purchase items just because the price is right.

Costco has a long runway. It's not a retailer being obliterated by discounters or the internet, but there are signs of weakness. These are two areas to watch -- and concerns management needs to do more to address. Neither presents a reason to panic, but growth has slowed, and this might explain why.

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Daniel Kline has no position in any stocks mentioned. He has to buy a coffee table, even though he does not agree with purchasing furniture merely to collect clutter. The Motley Fool owns shares of and recommends Amazon.com and Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.