Weekly Stocktake

The no-frills, ultra-low-cost warehouse retailer Costco, does everything it can to lower the prices of the products it sells. With the surge in inflation over the last two years, Costco is benefiting from the trend of people wanting to pay the lowest prices possible for goods. Here are some of the strategies Costco uses to keep their prices low.

• Costco keeps a limited inventory of the products it sells. This enables them to sell inventory before they are required to pay for it.
• They also don’t stock too much variety in terms of products, further allowing them to buy in bulk from their suppliers.
• Costco keeps the design of its stores extremely simple, reducing the need to spend much on marketing.
• Costco has an annual membership fee that incentivizes customers to shop more at their stores.
• Costco has built a strong business culture, resulting in low employee turnover. Companies lose out when their trained employees leave. They also offer higher-than-average compensation, which incentivizes employees to stay.

Last week, Costco released their Q3 2024 results. Total revenue for the quarter was $58.5 billion, up 9.1% year-on-year. Costco’s gross margin was 12.5%, far lower than many retailers. Operating income increased by 30.8% to reach $2.2 billion for the quarter. This represented an operating margin of 3.8% for the quarter.

Costco has built a cult-like fanbase among its customers, gaining customers across different income levels. Not only do they sell hotdogs for $1.50 and rotisserie chickens for $5, they also sell gold bars as customers attempt to beat inflation on another front.

Costco is trading at a relatively high multiple. Their price to earnings (PE) ratio is currently hovering around the 50 mark, whereas Walmart is trading at a PE ratio of around 28. Costco operates in an extremely competitive industry with very low margins. Any missteps in their operating activities could cause their bottom line to suffer tremendously.

Walmart is held in the Lunar Capital BCI Worldwide Flexible Fund and by Lunar Capital’s Offshore Portfolio Clients

Last week, Walmart released their Q1 2025 results. The group’s revenue reached $161.5 billion for the quarter, growing 6% year-on-year. Operating income rose by 9.6% to $6.8 billion. Walmart’s gross margin increased from 23.7% a year ago to 24.1% this quarter. This improvement was due to fewer inventory markdowns compared to last year. Additionally, Walmart’s advertising business, which typically has a higher gross margin than general retail, has been growing faster than other parts of the business, contributing to the overall margin increase. With this in mind, Walmart’s management team stressed that they are trying to keep their product gross margin as low as possible so as to incentivise more customers to shop with them. Walmart indicated that they have seen a meaningful increase in higher-income earners shopping at their stores. Walmart’s e-commerce business grew by 22% on a quarter-to-quarter basis, showing good returns on their technology spend.

Walmart and other large retailers generally perform well in inflationary environments. They can buy in bulk, which helps lower their prices. Additionally, when they place orders in advance, they secure prices at that time. Once the goods are delivered and ready to be sold, the new, higher inflationary prices are evident in the economy. This allows them to sell at those higher prices or slightly less, giving the impression of saving customers money compared to smaller and/or less efficient businesses that order closer to the time of sale.

Walmart faces intense competition worldwide. They not only compete against local retailers but also against giants like Amazon, which has a highly profitable cloud business. From its inception, Walmart has focused on serving underrepresented locations, offering customers an all-in-one store with “everyday low prices.”

Walmart is held in the Lunar BCI Worldwide Flexible Fund and by Lunar Capital’s Offshore Portfolio Clients.