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Costco, Wal-Mart, and BJ's



March 28, 2011 – Comments (2) | RELATED TICKERS: COST , WMT , BJ.DL

Board: Berkshire Hathaway

Author: michaelservet

We prefer shopping at Costco, not least because the parking is far less of a hassle. But we own WMT stock.

Same here. I don’t spend $30/year at Walmart and won’t go into BJ’s anymore, but I’ll go to Costco (10 miles beyond) even just for lunch. I really overdo it: last year’s Costco membership refund was in flat-screen-TV territory.

But as a shareholder, like Berkshire and you, I like Walmart. A year or two ago The Fool had that banner ad saying they’d identified the retailer that was going to knock off Walmart. If we followed the link – who could resist? – we saw they were referring to Costco. But of course that’s ridiculous. Costco and Walmart have completely different customers. And Costco’s demographic group is much smaller.

Most of America can and does shop at Walmart. Much of the world can afford to, and can benefit from the privilege. While Costco’s unit pricing on items might be better, its bulk purchase requirements and higher-dollar offerings put it out of the reach of much of America and most of the world. Walmart’s core customer is paycheck-to-paycheck. Costco’s proposition doesn’t work for that demographic.

On the subject of leverage, financing, and float, Walmart and Costco both excel in another area: supplier financing. Combined with good inventory management and the resulting high turnover, aggressive supplier terms are a form of free float. Costco has historically had more than 100% of its investment in inventory paid for by suppliers (ie, they completely sold out and even received the re-order before the bill for the first shipment was due). They are ‘down’ to having their inventory 97% supplier financed now. This is still pretty remarkable, considering they do a considerable private label business.

Similarly, Walmart has 92% of its inventory level vendor-financed. Two years ago, when Walmart was at the peak of its private-label foray, Walmart’s inventory was down to 84% financed by suppliers. But Walmart recently has gone back to emphasizing national brands. Customers weren’t recognizing good value in private label, even though it might be inherently there – but they were able to see the value in Walmart’s low pricing of national brands. So brands are back.

That’s good for brands such as Fruit of the Loom and Russell, but in return for throwing business their way, Walmart obtains excellent payment terms. Buffett, particularly, must have an appreciation for the idea that Walmart can extract free financing from him, and that he’ll gladly(?) provide it. (Including McLanes and Berkshire’s brands, Walmart is easily Berkshire’s largest customer in dollar terms, representing maybe 7% of Berkshire’s top line revenue – though of course a minuscule share of its earnings).

To an earlier comment about retail metrics, and how the focus should be on earnings – one of the more persistent things we keep hearing in the news is is ‘same store sales.’ Innumerable analysts and financial reporters have written about the importance of this particular metric. And understandably. But this is one of those mostly-for-public-consumption things. Internally, retailers – at least the good ones -are fully focused on profitability, and there is far, far more emphasis of the profitability of each incremental sales dollar than on a ‘same store’ sales performance number. Almost any retailer can get sales growth. Profitable sales growth is another matter altogether.

I know I’ve said this before, but another thing to remember is that there’s no industry standard for ‘same store sales.’ Most retailers these days now include their internet business in ‘same store’ reporting, as well as the impact of store remodeling or expansions, or even where they’ve closed a store in a city and opened another in another part of town. This is misleading, of course, and if they were giving credence to these comparisons internally you’d question their common sense. Walmart, to its credit, generally doesn’t play those reporting games (it also doesn’t include any of its more rapidly growing foreign store performance in its ‘same store’ reporting). Not to say that domestic sales trends shouldn't be a concern, but that's only one element of the larger picture. The financial press and markets are incredibly obsessed with that metric, however, and will likely be for awhile.

These days, it can be instructive to look at sales and earnings this past year compared to pre-recession (2007) levels. Otherwise, it’s too easy to get lost on the period-to-period noise. On this basis, Walmart had an overall 12% revenue increase from 2007 to 2010 – and a 19% increase in earnings. Costco had a 20% growth in sales and 20% increase in earnings, 2010 vs 2007.

2 Comments – Post Your Own

#1) On March 28, 2011 at 4:32 PM, eldemonio (98.09) wrote:

Damn it! I clicked on this link hoping for some sweet BJ action.

Walmart's prices are low, but not as low as the standards of the people shopping there. 

Shopping at Walmart feels kinda like taking a trip to a third world's dirty and you get to see barefoot children randomly wandering around.


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#2) On March 29, 2011 at 6:49 AM, xiaoqiao75 (< 20) wrote:

Sorry but I work and live overseas...for Walmart.  Walmart's stock price took some recent hits because of same store sales in the US but the future is overseas.  Between China and India, nearly 1/2 of the world's population sorely needs as low a price on consumables as possible to improve quality of life.  No one does that better than WMT.  As for evaluating retailers, take a look at free cash flow.  Nobody can generate free cash flow like WMT.  I believe the S&P target price is a fair 12-month target valuation.  The stock is undervalued at present...being so big it is tough to get respect.

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