[Stock Geekout Ep 6 – 22 May 2021]

In Episode 6 of Stock Geekout, we geek out on retail giant Costco with Chris Susanto, founder of

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podcast Transcript

Reggie: Today in TFC Stock Geekout, we’re going to explore a company that rarely makes the media circuit. In other words, it’s a little bit boring, very old school, but has an extremely strong brand and following amongst its members and consumers. With 90% membership retention rates, they are very happy. A lot of happy customers, and this is a concept that is extremely popular in the US and has recently entered in China. 

But for many of us locals in Singapore, we may struggle to understand how one company can set up a huge warehouse selling day-to-day products without making the aisles look amazing and welcoming. So imagine Sheng Siong warehouse, where you have to become a member, you have to pay money to join then you can shop. Will you do it?

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Joining me today to geek out on this supermarket giant is Chris Susanto, founder of… someone that loves great deals in the markets. So we had to talk about this great deal powerhouse called Costco. They run a business model where you buy in bulk, you have to pay to shop, and yet you have the highest revenue per square foot and the lowest operational costs. Essentially, they are very, very cheap. They know how to make things very cheap. Find out how they do it and why it is a little bit difficult to challenge their model, although they don’t sound that tech savvy. 

For your reference sake, this episode was recorded on the 22nd of May, 2021 and released early to our community members. Our discussion today is solely for education and entertainment purposes only. It does not serve as any form of advice or recommendations. Thank you for loving what we do and empowering us financially to do more for you. So let’s geek out!

Yeah. So guys, recently, I think a lot of things are happening in the market and we are locking down again. Okay, maybe not locked down… like pseudo lockdown. 

Chris: Phase 2, Heightened Alert. 

Reggie: Whatever phase… and you’re seeing people rushing to Sheng Siong, NTUC and all those kinds of stuff once again. And maybe not as crazy… 

Chris: And the stock price went up. 

Reggie: … as the first time. Yes, yes, exactly. Sheng Siong’s stock price went up. So we may have moved on from the whole Sheng Siong train, but there are many other retailers and many other big grocers out there in the world. It’s not just local to Singapore. 

Today, we’re going to spend some time with Chris again and we’re going to talk about the essentially one of the biggest retailers and biggest grocer. Do you call them grocer? I think they are a lot more than a grocer at this moment in time, so yeah, one of the… 

Chris: It’s a warehouse club. 

Reggie: Exactly, one of the biggest guys in this space of selling goods in bulk. I think not so common here in Singapore, people don’t really buy in big bulk. So you really got to help us envision and understand this thing as we go along to try to understand this business. So what are we going to talk about today, Chris? 

Chris: We are good to talk about Costco today. As usual, whatever I say is for educational and informational purposes only, the usual disclaimer. So Costco is a very interesting kind of company. You look at Sheng Siong. Sheng Siong is like… or you would say is a pretty big in our Singapore context, but Costco is big in a global context because… 

Reggie: I like the “BIG”. This is like really big guys. Not just Sheng Siong. Yes, I get that. 

Chris: Yes. Costco is very interesting. Reggie, can you guess how many stores they have all over the world?

Reggie: Wow. I don’t know, 1000 stores? Or 30 000 stores? I don’t know. I don’t know, man. How many do they have? 

Chris: They have roughly, based on what I saw as of… around 2020, is around 795 stores worldwide. So you wouldn’t call that a lot of stores for such a big company, because each of their stores, you see it in the form of view like a warehouse club.

It’s not like your 7-11 or like it’s not even like the size of Sheng Siong. It’s usually very big because it’s more of like in the form of warehouse and they get most of their sales from the United States, around 73% and Canada, around 13%. Although it’s a global company, most of their sales still come from US and Canada, which is about 86% of their sales. 

When we go to Sheng Siong, anyone can just go and anyone can just buy stuff. But when we go to Costco, not everyone can just go and not everyone can buy stuff because you need to be a member first. So that’s the very interesting thing about Costco and their value proposition from a long time ago where they were founded around in 1983 is really about low prices on a limited assortment of products. They don’t sell everything in the world, but when they sell those things on a limited basis, you can see that the price is very, very cheap. 

Their focus is really not on… displayed until very nice, have lots of decoration inside the stores. That’s not their focus at all. They basically just get from the suppliers and then from the suppliers, they just push it into the warehouse and then they just open the top. Something like that. 

Reggie: I know. It’s like the crates, like those fork lifts, the very big fork lifts, they go in and they take down this whole big stack of things and then they just put it on the floor. They open up the top lid and then you just take whatever you need to take. 

Chris: Exactly. 

Reggie: It’s extremely uncommon here. People in Singapore probably find it very hard to envision, but I think the closest guys will be the one at Jurong, the Big Box store at Jurong. I think that’s the closest guys, but when I was traveling around, when I was staying in the Philippines for a short period of time, like a few months, there were a lot of these kinds of stores also, where it’s the exact same idea. This whole thing, just put it on there. No display, they’re not try to amp it up and make it swee-swee (nice). They essentially want you to take the whole box if you can. They really want you to sell in bulk. It’s kind of what it is. 

Chris: Yup. So I think that’s what differentiates Costco as well, because if they do this, then they can lower down the costs that are not really essential for the purpose of their competitive advantage or their moat, which is low cost. As a result, as you can see, they earn a lot of money from their membership. You can also see their membership actually is steadily increasing even though they’ve been around for so long. Even if you can see in the past, maybe we just look at 2015 to 2019, their membership has increased from about 44.6 million members to about 53.9 million.

Reggie: Wow. 

Chris: And that is after growing for so long and not only that, the average sales per warehouse has also been increasing. 

Reggie: Wow. 

Chris: All the way from 2010 to 2019, the average sales per warehouse has also been increasing. That means that each of the warehouse actually has more members going there and therefore the average sales per warehouse is also increasing and therefore you see that, although it doesn’t have as much stores as say, Walmart, but their average sales per square foot is very high. In fiscal 2020, their average sales per square foot is about $1400 comparing to Walmart’s of about $485… at Kroger’s, $680. 

Reggie: Wow. 

Chris: And I mean… yeah, yeah. 

Reggie: That’s like… 

Chris: So you can see… 

Reggie: Wow. Very… especially important for this kind of… do you even still call them retail? In some ways, they are retailing from a warehouse angle, right? They’re building this thing that is not as beautiful, but they are still selling to the end tier customer. So in some ways, they are still retail and for retail business, to be able to churn to 2X, 3X, 4X their competitor per square feet, that is amazing. Wow. 

Chris: Yeah, that’s amazing. That means that people really buy stuff in Costco and they buy lots of stuff in Costco because of course, they view Costco as the value buy. I mean, who doesn’t want a good value, right? I think that’s the reason why their paid membership has been steadily increasing over the last five years. Their renewal rate for the United States and Canada is about 90%, so that’s very high. 

Reggie: Wow, it’s very high. Yeah, Spotify is at 50%. Just saying. 

Chris: Really? 

Reggie: Yeah, Spotify’s retention rate is at 50%. That’s low. That’s very low, problematic for them, but wow. 90% renewal. If you think about it, it’s no joke, man. That kind of customer experience must have been amazing for a lot of them to continue to keep paying for membership. Wow. 

Chris: Yeah. I think it simply means that these people know that how much they pay for a membership, they’re able to save more from buying from Costco. Their worldwide renewal rate is 88% based on what I saw from the 2019 annual report. For a company that has grown so long and so big, meaning that they do have quite a sustainable business model because you see that these customers really value their membership. 

They are quite smart because they know that people are buying and they know that they have these members, so they also have a really good amount of their own in-house brand. They have this Costco Kirkland signature brand. Have you heard of this brand, Kirkland? 

Reggie: No. 

Chris: It’s by Costco, but the interesting thing… do you know that their in-house brand, from what I read recently, accounted for around 25% of their sales?

Reggie: Wow. That’s… 

Chris: That’s a lot. 

Reggie: A lot, and that means they’re very targeted in their kind of in-house brands that they are going to develop and that’s extremely powerful.

Chris: Yeah, that’s crazy. I mean, if you think about Sheng Siong, can you imagine that 25% of sales is in-house brand by Sheng Siong or in-house brand by FairPrice? No, right?

Reggie: No. 

Chris: Yeah, so it again shows the power of not only the stickiness of the company, but also the company’s ability to do R&D (Research & Development) and develop product that customers do find value and buy. As you know, in-house brand is definitely better margin for Costco than getting brand from outside. 

Reggie: Always better. In-house brands always have better margins, yes.

Chris: Yeah, so Costco is very interesting. In fiscal 2019, I think they opened their first store in China with over…

Reggie: With a big commotion. With a very big commotion. 

Chris: Is it? 

Reggie: Did you see? You didn’t see all the videos going online? 

Chris: I didn’t see. 

Reggie: Oh my god, the videos. They were like… You know China being China, there are so many people, right? When Shanghai Disneyland was opened, the Disney part was like flooded and there are like so many people and rides were taking so long, right? You take that same experience with Shanghai Disneyland into Costco. The first Costco in China, that’s the exact same reality. People were pushing around and there were no stock left. They sold out in, I think, a matter of hours on the first day. They didn’t expect so many people to come. It’s crazy. It’s crazy, man. Wow. 

Chris: It’s crazy, right? 

Reggie: Amazing. 

Chris: I think that speaks to the power of the brand also, even in global context. I mean, Costco is a US company but even when they opened in China, there’s so much commotion and there’s over 139 000 memberships sign ups by their first day. By their operating day, there’s so many signup already. Do you know just in 2019, in fiscal 2019, what was their net sales for the year? 

Reggie: I don’t know, man. 

Chris: It’s $149 billion, man.

Reggie: What the f*? They essentially sold like wow… They sold a lot, a lot of goods and 25% of them are house brands. That’s crazy. It’s pretty, pretty damn well. Okay, I think here, we gotta paint some clarity, right? One is they are… in their business model, one is the membership. The membership is extremely interesting because people must be experiencing sufficient value that they can continue to sign and be part of the member.

But when you are a member, then you have a higher propensity to go back to spend also. So that’s another very… powerful being a member. From a business standpoint and from a consumer standpoint, they all extract value out of this membership and it’s steadily growing. They are charging extremely cheap for the products that they sell and because they do not try to make it look swee-swee (nice) and everything, they don’t need to hire all these random people to beautify it. It reduces the supply cost. 

I think that’s extremely important and they are doing a lot of house brands based on what they have so far, because they have all the data. What are people buying? It’s like everybody buy rice, then you do a rice kind of thing, right? With all that data, you can have a higher hit rate from what product to develop. So I think in that sense, it’s a pretty interesting business that it’s not very techie, not very futuristic, but it seems like the core value is pretty there, huh?

Chris: Yup, exactly. So I think the interesting thing is that now we are living in a world of Amazons and we are living in a world of online shopping and we are living in a world where even groceries, you can buy online with Foodpanda, FairPrice etc. But even as these digital sellers expand, I think Costco is in a very interesting position because their value proposition is also focusing on online also. Because in the US locations, 99% of their US locations, from what I read, is within a 20 minutes’ drive to members. 

Reggie: Wow. That is very strategic in the way they built their stores.

Chris: Exactly, and when you go to Costco, as I’ve mentioned just now, the members know that they don’t have the biggest variety like we can see in Walmart or Target. In Walmart, from what I read, in Walmart Supercenters, that means the bigger Walmarts, they have about 140 000 stock keeping units, so 140,000 different kind of items. In Target, maybe 75 000 – 80 000. But in a Costco warehouse, they only have about 3700 stock. 

Reggie: Huh? Bro, that is damn lean. Very, very lean.

Chris: Yeah, despite the warehouse’s large sizes, which is normally about 140 000 – 145 000 square feet. So can you see what’s the impact of this? That means that they have really strong purchasing leverage because they don’t buy so many things, only 3700 as compared to Walmart’s 140 000 or Target’s 80 000. So that means that since they don’t buy so many things, each of these things, they buy a lot. That’s why they can buy in low cost and that’s why people keep on coming. 

Reggie: Yeah, and they built their own house brand to bring down that cost even further. They can have that competitive advantage compared to all these other players that are doing the whole swee-swee (nice) experience, selling retail.

Chris: Yeah. They really don’t try to make a lot of money from selling their stuff, because most of their earnings, from what I see in fiscal 2020, 65% of their earnings before interest and taxes is from membership fees. 

Reggie: Really? 65%?

Chris: Yeah. 65% percent of their EBIT (Earnings Before Interest and Taxes) is from membership fees in fiscal 2020. 

Reggie: They are like a co-op, bro. They’re essentially like a co-op. They buy things in bulk. 

Chris: What is co-op? 

Reggie: A co-operative. So they buy things in bulk together, they congregate together and they share their value amongst their own people. That’s pretty interesting. That’s cool, that’s cool. 

Chris: Yeah. 

Reggie: That’s nice. But who are their competitors in the space and with this model, do you think they can continue to keep growing, relative to all their competitors?

Chris: Yeah, I mean the competitors for Costco are the companies, the household brand that you and I know, like Walmart. Walmart is really the biggest America’s retailer by sales. But Walmart also make most of their money from the US, about 77% of their sales. Of course, Target is a competitor also. Target is, of course, not as big as Walmart, but it’s really a strong competitor as well.

But of course, in terms of the business model… might not be entirely comparable because they are not operating on a membership warehouse sales basis. There’s this company that’s also a competitor called BJ’s Wholesale Club Holdings. It’s a warehouse club and gas station operator. Maybe this one is a little bit more comparable. We have another big company that we can compare against called Kroger. Kroger has about 2750-ish supermarkets worldwide and 82% of them have pharmacies. The business angle (is) also slightly different, but I think there’s a market for all these companies. 

If you look at Sheng Siong, I don’t think Sheng Siong will go bankrupt in times of Covid or in times of no Covid, people still need to go and buy their groceries and as you know, we will usually buy nearby our house or wherever is convenient, right? So that means that each of these stores have their own market and I think it’s very hard for all these companies to go bankrupt 

Costco is in a very interesting position because it strikes to the heart of what consumers want: value, right? Especially if you have a family and you have to cook for them and you have to stock up. Since you’re going to buy things anyway, you want to buy it at a bulk because it’s cheaper and that’s where Costco comes in and since you’re already a member of Costco, why do you still want to go to Target?

As you have seen just now, Costco says that 99% of its location are within 20 minutes drive in the US. But of course, Costco is not suitable if you just want to buy for one person or for two person. Basically, if you want to buy in bulk, go to Costco. But if you don’t want to buy in bulk, then maybe Costco might not be the best location because you need to pay membership fees and things like that. So there’s quite a sustainable differentiation that Costco have as compared to its competitors.

Reggie: So then you’re seeing two things, right? One thing is they’re limited in their growth opportunities in a sense that they need to be in a particular region. Because they are not the only player and then if their competitors become a dominant player in that region, then it will make it pretty hard for them to enter. Is that one thing? 

Chris: No, I don’t think so. I think Costco has their own market and has their own value proposition and if you look at their EPS (Earnings Per Share) compounded gross rate for the past five years, maybe until 2019, 2020, we see that Costco’s earnings per share actually grew faster than the other four companies that I mentioned just now. Their earnings per share grew at around 11.2% as compared to Walmart at 5.53% and Target at 8.72% and Kroger at 4.55%. BJ’s EPS (Earnings Per Share) is still quite erratic. It has a negative EPS (Earnings Per Share) in one of those years.

I think they do have a key differentiation and their key differentiation usually is through… really not trying to make money. I think that sometimes they don’t even mind like losing money on some products just so that the customers keep on coming and finding value because they make most of their money found their memberships fees. 

If you look at the gross margins, it is not surprising that they have the lowest gross margins out of the four supermarkets that I mentioned just now. Their gross margins from the last time I saw, I think it’s only at around 13% range while Walmart is around 25% range, Target is around 29% range, BJ’s around 19% and Kroger on 22%. 

So I think they can compete in anywhere that they decide to come because of their branding and also because people know Costco is cheap, Costco is value. I mean, there will be a market for families etc.

Reggie: Fair. So then in that sense, they are the top of the mind for the cheap value kind of company. But then do you think that they can then compete internationally because there needs to be some sort of growth story, right? If you think about it, there are two things, right? One is how are they going to continue growing? The other is in the space that they already in, it is not actually a very difficult model to copy. You know what I mean? So if it’s not a very difficult model to copy, why nobody copying them and how can they continue to stay relevant and continue to stay strong? They are relevant… continue to stay strong? 

Chris: I think it is a difficult model to copy because if you are a supermarket that is not built on this model from the ground up, then it’s very hard for you to suddenly become this model from the ground up because this model requires you to have large warehouses, requires you to have the whole company policy revolving around not trying to make so much money from the things you sell. If you can sell cheaper, sell cheaper, don’t sell higher. The people you hire are not really the people to beautify the shops or things like that. You don’t really see them having rent or long-term rent in shopping malls. 

It’s really… the whole business is built on this kind of philosophy, so it’s not easy to copy. If you want to copy, must start a new company from the ground up to really focus on this model, because it really requires you to limit costs on many, many things so that at the end of the day, when people go to the shop, when they buy the stuff and they can see that “oh, it’s cheaper.”

But of course, with this kind of brand recognition, some of the things you buy in Costco might not be cheaper, but you think it’s cheaper anyway. 

Reggie: Yes, yes yes. I know what you mean. I know what you mean. A lot of retailers actually do that also, right? IKEA is one of them. IKEA is a classic retailer that does this. They have a few products that are really cheap and they sell their ice cream and all those things very cheap so that it creates a brand identity that pulls you into their store. You will buy the cheap stuff, yes, but at the same time, you will somehow buy the other things that actually have a very big margin and you didn’t realize. You thought everything at IKEA is very cheap, very good. 

That’s one powerful thing. That’s very interesting, but at least knowing this, it gives people that are new to try to understand this company, the comfort to know that you are supposed to expect Costco’s margin to be very low because this is their business model. You cannot compare it with another retailer. That is something that I think we all have to be aware of, right? 

Chris: Yup, yup. Definitely. I mean, when we look at any company, we must ensure that… of course we must understand the company before we invest even a single cent into it, but the idea for any company, you must see what makes them different and how certain are you that it’s different and what is the sustainability behind this differentiation or this competitive advantage or moat, or whatever you call it. The reason is the sustainability of this competitive advantage and whether this competitive advantage will be bigger or smaller, is it growing into the future, will likely translate into the numbers.

Because only when you see a company have clear differentiation, then they can have this kind of a stickiness or whatever you call it. Some companies have pricing power etc. For Costco, I would say it’s like a switching cost or maybe it’s… yeah, probably, low cost. I would say low cost is their competitive advantage.

Reggie: Yes, and like you said, it is very difficult to build a retailer whole thing around low cost. 

Chris: Yah. 

Reggie: I think one of the things that caught my eyes in the financials is that from operating expenses to revenue, that means the overhead costs, Costco is only… it’s sub 10%. It’s at 9.47%. Everyone else is hovering at about 20+%. That’s pretty nuts, right? That means every dollar that you spend at Costco, about $0.095 go to operations. 

Chris: Yeah. That’s crazy low, right? 

Reggie: Crazy. 

Chris: If you look at Walmart at about 20 something %, that means that if you want Walmart to suddenly become Costco, you must ask Walmart to cut half of their stuff. 

Reggie: That is pretty wild. That’s pretty wild. Interesting how this business model will thrive. It’s not even like some corner store indie shop. It’s like a big cooperation and this model actually worked all around. Can you bring us through a little bit of the numbers? What are some major things that we should look at within their financials, within the numbers? How is it looking like? 

Chris: Yeah, they have a very low overhead ratio and in terms of their debt, I think from the last time I read about it, their debt to equity is roughly around 0.4 something. That’s comparatively quite low because on average, I think they have no problem paying off their long-term debt with their net income or their operating cashflow, free cashflow etc. Their free cash flow actually, if I’m not wrong from 2015 to 2020, their free cash flow actually is growing at about 26.18% for the last five years.

Reggie: Wow.

Chris: That’s actually very, very… 

Reggie: Very high. Even the tech companies may not perform like that. 

Chris: Yeah. I mean there’s a reason why I think Charlie Munger is a very long-term owner of Costco. Very long-term.

Reggie: Cause he is a cheapo at heart. He’s a cheapskate at heart, he knows. He likes the deals. So exactly, this is where he hangs out. 

Chris: I think because he knows that also this competitive advantage is very hard to fight against. Even if you have new technology, how can you fight low costs for groceries and for their own in-house brands like Krogers? So I think that Costco has a really… quite a solid profitability, really well managed as well in terms of its debt. 

But I would say that its valuation has never been… I would say very attractive and if you can look at the price chart, wow, it’s like just going up all the way. It also shows that… I know they have operationally done well over these years as well. Yeah, so I mean, these kind of companies then of course, if you want to think about valuation, how can you value it? 

I would say that we can consider maybe using your standard discounted cash flows, assuming certain amount for the free cash flows. So like we mentioned just now, their free cash flow grew at about 26-ish % from the 5 years before 2020, 2019. If you think about the valuation, if you just assume, maybe just about 12%, if you try to be conservative, so you half that, free cash flow growth rate to 12% for 10 years, and then 5% perpetually, you get about like $430-ish with a 15% margin of safety.

If you assume a 16% growth rate for the next 10 years, which will be harder to do because they’re already quite mature and they’re really quite big, then there’s a bigger price upside of about $581. But of course, if that is your assumption for Costco. 

But in general, I’ll say that Costco right now is… based on my assumption, is not something that is widely overvalued, but it’s also not something that is very mouth-watering either.

Reggie: Yeah, and you like the mouth-watering ideas, I know.

Chris: Yeah, I do. I mean, I try to be disciplined about it, although sometimes it can be hard, right? 

Reggie: Yeah. I get it, especially when there’s nothing to buy, then you look at this. Actually, this is not too bad.

Chris: Actually, not bad huh? 

Reggie: Yeah then you will be like… 

Chris: Not bad huh? Just put some. 

Reggie: Just try a bit, it looks not bad. Anyway, this is not recommendation but this is exactly how a lot of investors think, right? When you’re in the market, you have all these capitals sitting around and then you’d be like “wah piang, everything is so expensive.” What do you go for? Some people will trim their margin of safety. Some people will trim their positions in a sense of thinking like “oh, maybe this company can go a little bit better.” So then, you will buy the less mouth watering deals, but still not too bad. But ultimately, it is based on your individual understanding and your individual palate, your own investment style.

Chris: Exactly. It’s about discipline. It’s about patience. It’s about understanding yourself, controlling yourself. That’s why investment is really art and science, combination of both to really have clarity in who we are, how we want to invest and of course also clarity about analysing the company at hand. 

Reggie: It’s great. I think we’ve talked a lot about it. Do you want to walk us through a little bit… what do you think of their management? Are there any interesting people in their team? Do they have certain moats that… I mean, we’ve definitely talked a little bit about their moats but I just want to want to hear it in a form together.

Chris: Yep. I think their management is pretty decent. The CEO is Craig Jelinek. (He) was the CEO from 2012. As you can see, from 2012 to 2020, they have done operationally very well. Membership renewal rate remained high, membership continually increased. Average sales per square foot is also really good, continually increase and really… as we’ve mentioned just now, almost triple like Walmart. Their debt management is also good. 

They have also tried to achieve better growth objective in terms of their e-commerce and fulfillment capabilities. I think they are also trying to to have the… what you call the “one-day shipping” capabilities and…

Reggie: Amazon has set that as a basic. Because of Amazon, you have to do it at this level, if not… it’s all relative. 

Chris: Yeah, I think they are trying to do the same day grocery delivery for members. They have really good track records of store growth, a really strong execution… develop their omni-channel capabilities to really fight against the digital disruption quite well. So I think the management execution is good and because of this, of course, it sort of adds to the overall competitive advantages as well, because I’m sure you know that the biggest risk in competitive advantage other than competitors and the type of business is also the management, right? If you look at Netflix, there’s Reed Hastings and then you look at Starbucks. Yeah. 

Reggie: Yeah. I definitely… I think the team is extremely important. But like we’ve pointed out, in terms of their moats, it’s really about the low cost supply chain that they’ve built and it’s not as simple as “let’s just build a supply chain like that”, because at every corner, you have to think of it this way and you have to build it in such a way and that’s crazy. The kind of retention and stickiness… 90%, my goodness, of their membership, really calls for it to have that kind of continued value. Because like we’ve talked about in the beginning, it’s a cycle. Members go to stores. More stores, more members and more members, more stores and then it becomes like a cycle and you keep opening and keep doing new things, on top of trying to see all these other digital transformation.

With that in mind, you’ve already said that they are extremely matured… at least in their part of the world. In the US, in Canada, they’re very matured and they are like household names. So then how are they looking to expand? Because if 65% of their revenue is coming from membership and they’re not really banging on selling more products, they’re trying to grow more members, I’m assuming that they have to open more stores and it’s not just about omni-channel. You know what I’m saying? 

Because for other people, omni-channel is selling products. That’s extremely important to them. When they have more channels to sell more products, that’s great. But for these guys, 65% come from members. They need more members and not push more products. So what is their growth strategy? 

Chris: I think it’s all related to each other. Only if members find value in the products, they buy more products, they find value in the members. For members who don’t buy more products, they don’t find the membership useful and they wouldn’t renew. 

There’s a couple of growth areas for Costco, the same with Netflix, which is how strong is their pricing power and how can they increase price without increasing the churn rate of customers by a lot? It’s good news that Costco’s renewal rate still remains high at about 88%, 90% ish. So that means that… really only when customers buy more products, they will find more value in the membership. It’s logical, right? 

Reggie: Fair, fair, Yes. 

Chris: And then, that means that if let’s say Costco decided to increase the membership price, which they have increased quite a couple of times without reducing the churn, then they have an immediate increase in revenue and the revenue increase is huge because they have so many members. 

Reggie: Exactly. 

Chris: Yeah, it’s huge. It’s in the hundreds of millions. 

Reggie: With the free cash flow… because that is a direct free cash flow. You can then further invest and you can do other things and you can continue to multiply. So it’s actually extremely powerful.

Chris: Yeah. So they just have to add more value and that’s how they can grow. They don’t necessarily have to make lots of money from the things they sell, but they still do. They make the money from the membership and they can increase the price of the membership in the future if there’s inflation or what.

Yeah. So, I mean, the thing to take note of for Costco, I would say, is really trying to observe and monitor the competitive advantage, on the durability of it, the value add that they bring to the members. It’s like Netflix, right? If you don’t find any more good movie, you don’t find any more good value okay, bye bye, right?

Reggie: Like recently, right? Recently, there’s no good movies. I was like “oh my god, it’s so boring. I’m going to quit.” 

Chris: Really? 

Reggie: Yeah. There’s nothing good. I really finished a lot of those… okay, it doesn’t help when you are at lockdown at home, you have a little bit more time. You start to consume these things in a much faster pace. So if you think about it, based on the calendar of Netflix, they may not have priced in that kind of high consumption level and given the lockdown, but we can talk about Netflix another day. So that’s the part. 

Are there any major growth plans for Costco. They’re in China now, right? So that is definitely a very big consumer market to be. What are their strategies there and what are we seeing, going into the future for them? 

Chris: I’m not really sure specifically in detail, what’s their strategy for China, but I would say that people all over the world love cheap products. So I think anywhere they go, that’s their strategy, which is really providing as much savings as they can, providing as much value through the similar strategy: leasing a big warehouse, maybe what IKEA is doing… or maybe not as big. I’m not sure, but basically reducing their operating costs and giving as much value to members. 

I think that is how they will grow in the future, mainly just opening more stores and increasing the price of the membership without reducing their churn by a lot. But I wouldn’t say that it’s the kind of your tech companies… like huge growth rate, huge revenue growth rate in the 50 hundred %. Definitely no. It’s a matured company, really quite solid in terms of what they are doing and what they’re doing for a long time.

Reggie: It’s the kind of company that… it will not enter the media circuit. Nobody cares about them. They’ve just been… they’ve just been doing that thing all along. They’re like the kid at a corner, always just do very well for class, but not popular at all. It’s just doing its thing and just making it work. 

Of course, I think the China growth story is always something that people really want to amp up and make it sound all sexy and all, right? But I think this is the part where we got to see how management really executes in China, because it’s definitely not the same as compared to in the US because they have the whole supply chain already built within the US. Of course, they definitely take foreign products coming in, but it’s very different relative to operating in China and China is so fast, in terms of competitors competing and trying to…

Chris: Yep. Yep. Yep. 

Reggie: … put together a model and attack you. You look at Luckin coffee, right? Shit happened, but dude, they managed to rally so much capital behind building a brand that tried to rival Starbucks. You know what I mean? So in China, whatever model that you think works, they will copy and they can make it so fast, so amazing. So we really got to see the kind of consumer retention in the space. Also, we got to see the expansion plan over time as it plays out and see whether they can continue to get their footing. If they can double their storefront, essentially repeat what they’ve done in the US in China, then that will be an amazing business. 

Chris: Exactly. 

Reggie: But are you concerned about their competitors copying them? Although yes, we say that it is not so easy to build a whole supply chain from scratch. But if you think about it, there’s also the whole supply chain of discount supply chain, which I think people that look at retail business, they understand. Whenever the product does not move, it moves into the discount channel and then it will pass down to different people like Daiso, all those guys. They are actually just discount channels. So what is stopping Walmart of Target or anyone else from setting up a same model with Costco as a form of… like a Walmart discount channel? 

Chris: I think there’s nothing stopping them and definitely there’s always a risk. But in investment, we must always think of the probability of that risk, right? Is it high or low? The way I see Costco is that… another reason why it’s not easy to copy them, simply copying them, I think they might have the strongest… I think they might have the strongest purchasing power in the whole of US because they have so little SKUs (Stock Keeping Unit), about 3000+ as compared to other supermarkets with tens of thousands. With the little SKUs (Stock Keeping Unit) and they have the highest per sales per square foot, that means that they really buy a lot of that one thing, and with that kind of purchasing power, then they can really push the supplier to the lowest. 

So if you want to start something new, you won’t buy as much as Costco definitely. It’d be crazy to buy as much as Costco and again, is… I think every brand stands for something. I don’t know if Walmart and Target want to suddenly stand for low cost supermarket. I don’t know if they want to do that. They might do that, but if let’s say they do that, then will that cannibalize their current supermarket? That is also another question.

Reggie: That’s definitely something that is very real in the space, especially… I think for the local guys that are listening, in this part of the world in Singapore, Malaysia, people know the few brands like Cold Storage, Giant and Sheng Siong, all those guys. I think a lot of people don’t recognize that a lot of them are in one group, like Jackson’s Marketplace and Cold Storage and Giant. They are all in one group, they are owned by one company and then they move down the supply chain. Whatever freshest product comes in, it goes to Jackson’s Marketplace first, and then after two days it cannot sell, it goes to Cold Storage and after Cold Storage cannot sell, it goes to Giant. 

So there’s some sort of extended discount and brand correlation. Of course it’s a little more complicated than what I just said. But there is some sort of way where a lot of grocers, they actually move products down this path other than just discounting within their own… within their own brand. Because exactly what you say, does Walmart want to stand for this thing, like discount, cheao? Not everybody wants to be a Daiso, right? 

Actually, a lot of the wastage in the food space that we are starting to see, fundamentally is linked to this: pricing power. Because if I sell something at $10, I can sell 70% of it and I can make that, 70% on $10. If I bring it down to $5, I can sell it all but I’m going to make less from 100% of sale. A lot of big retailers are still stuck on this way of selling at a premium and they rather have the food wastage rather than do the whole discount thing. So I definitely get what you’re saying. 

Chris: Yeah. Because if you think about it, logically in Singapore itself, you don’t see FairPrice having FairPrice discount. 

Reggie: FairPrice outlet store. 

Chris: Yeah. I know that some of these supermarkets have a premium version of their existing supermarket.

Reggie: They call it FairPrice Xtra.

Chris: Yeah, Cold Storage also have a few kinds so it’s normally like the standard and the atas (upper-class). You rarely see the standard and then the discount or like the outlet. You see Giant. Giant stands for cheap also, right? 

Reggie: Yes. 

Chris: You don’t suddenly see that Giant have Giant Premium. It just don’t feel right.

Reggie: Yeah, and that’s the power of brand. That’s the power of building a loyal following, because over time you will have your own crew, right? If you build something in this brand, all the guys that come in will be for… will be standing for this idea and if you keep shifting around and you change them, people get lost. People don’t know what’s your value and all those kind of stuff. 

So that’s a very complicated, ongoing discussion, but I think fundamentally, Costco as a business has its own unique model and has found its footing, trying to expand abroad. We’re not sure how that goes. But at least at the core, we cannot discount… this cannot discount. Pun intended… we cannot discount this discount warehouse company that’s selling a lot, moving a lot of products, given the model that they have. 

Chris: Yeah.

Reggie: I think that’s great. We had a very good discussion on this and if you never brought up this company, I would not entertain looking at it because it is never in the media circuit or at least not within the recent history. For the past two years, people are not really talking about this company. So yes. Any last words, anything you want to share before we close this? 

Chris: Yeah, maybe just one last closing. Of course, there’s also the risk with regards to Costco because Costco is still primarily a warehouse, offline kind of retailers that offers really cheap products. But if you think about it in the digital world that we live in, if digital retailers are able to one day, scale and build distribution leverage to such a size as Costco, they may be able to offer comparable values to Costco’s offering. Plus, it’s digital, they don’t need to rent the warehouse. 

Reggie: I know who you’re talking about. #AmazonPrime. Yes, yes. Cool. So I think… very well discussed overall and for anyone else that want to continue to understand, definitely talk in comment section below and we will continue to have discussion for other companies as we go along. Thank you. Thanks for spending time with us today. Awesome. Thanks Chris. 

Chris: My pleasure. Thanks Reggie. 

Reggie: Nice.

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