As Grocery Competition Intensifies, Should You Buy Costco Stock?

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Join our Industry Focus: Consumer Goods cast as they discuss the recent sell-off in grocery stocks and the buying opportunity that could present for Costco Wholesale (NASDAQ: COST). Competition from Amazon and Whole Foods Market, in addition to growing challenges from German discount grocery chains Lidl and Aldi, may give investors pause. Learn more about Costco's non-conventional business model and the degree to which the company is insulated from these threats.

A full transcript follows the video.

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This video was recorded on Sept. 5, 2017.

Vincent Shen: I do want to move on to the other company that Matt mentioned specifically, and that was Costco. I like to think that this is somewhat familiar territory for Costco. You look at a Wal-Mart and its reputation for low prices. The company has a gross profit margin of about 25%. Costco, just half that at about 13%. And Costco thrives on undercutting the competition, because it's able to look past its store aisles when it comes to its bottom line. If anything, Costco is kind of a grizzled veteran when it comes to a pricing war. What do you think about the company?

Asit Sharma: Costco is the opposite of Kroger in this one respect. I said at the outset that Kroger is a conventional grocery store. And usually what we mean by that is, a grocer that tries to offer everything, hasn't changed much since its conception in the 1950s, when grocery stores first came about in their present form. Costco is non-conventional in that it entices customers to buy in bulk. So it has a differentiation that other grocery stores don't. You have to have an edge in the grocery industry if you're going to survive. Only a few companies have survived at any type of scale over the years. Kroger is one of them. It's an industry which sees multiple bankruptcies every few decades. Maybe coming in for another cycle, but that's a different story, different segment, which maybe we can tackle later.

I like Costco because, as you said, it's a grizzled veteran. It manages to find ways to grow comparable sales. I think this last quarter, comps grew 3%, and Costco showed an 8% total top line increase. And it's done this by a differentiating not just its total offering but the services component. We should mention that Kroger also has a few of these. Kroger owns some beauty salons, it has stations with gas in some of its grocery stores. Costco has its automotive centers, it sells its memberships, it has another path to revenue in its co-branded affinity card with Citi Visa. So it has a real diversified approach to its revenue, which has served it well.

The other thing I really like about Costco is that it's not so concentrated in the U.S. Kroger, as I said, is a global company, but most of its operations are right here in the U.S. Costco has about 30% of locations outside the U.S., and that pace is accelerating. This year, it's going to open a total 26 new locations. Half of those will be international. So on all fronts, it's got a little more insulation than Kroger does against the pricing onslaught that's coming not just from Whole Foods and Amazon, but the German grocers that we talked about, and others in the industry.

Shen: Yeah. I think the established international presence that Costco has, that's a very important runway for growth that a lot of investors look to. And even something beyond some of the services that they offer, I think Costco is another star, or a really good example of leveraging their in-house brand with Kirkland Signature, a very highly valued offering that customers love and will return to Costco for. Of course, a lot of these grocery stores have invested a lot in their private label brands, but I just feel like Kirkland Signature is one of the cream-of-the-crop examples.

John Mackey, CEO of Whole Foods Market, is a member of The Motley Fool’s board of directors. Asit Sharma has no position in any of the stocks mentioned. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.