Costco Bear's Den
by Rick Munarriz ([email protected])

So, Yi-Hsin loves Costco. Beautiful. It's her hernia if she enjoys buying Spam by the ton and the humiliating task of having your receipt checked on the way out. I know this Duel should be more about Costco rather than Yi-Hsin, but there's a colorful anecdote here that I can attribute to my fellow Fool and resident warehouse club addict that I think you should know about.

After a recent Costco binge, Yi-Hsin found that she and her husband would never get around to consuming some of her bulk purchases. Who could really? I guess one can tire of having to buy Doritos by the 300 count. Was there anybody at work who could buy off her leftovers? Thankfully she came across a hungry Dayana (TMF School) and the transaction kept both pantries happy. Dale (TMF Ralegh) joked that Yi-Hsin should have marked up the goods.

Not a bad idea. That way, between Yi-Hsin and Costco, at least one of them would have shown some decent profit margins.

Low blow? Perhaps. I will concede that razor-thin margins are standard features in the sector. Grub retailers simply make it up in volume. Even with meager premiums, if a company can turn over inventory like a flapjack flipper on an IHOP Sunday, the bottom line will be just peach-riddingly keen. I guess what I'm trying to say is that if Costco finds enough people excited about buying Visine by the gallon -- it gets the red (ink) out.

Of course, we all know the king of making it up in volume is Wal-Mart. What a formidable competitor Sam Walton's company would be if it were to expand into warehouse club retailing. What was that? It does? Oh, that's right, Sam's Club. If the pure warehouse clubs were destined to be a growth sector, having Wal-Mart as a rival would have me quivering with fear and waving a white hanky soaked with my defeated tears. But, you see, it's not.

Despite all the hype in the earlier part of the decade, the industry has hit a brick wall. Sam's Club, Costco, and warehouse wannabe Smart & Final <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SMF)") else Response.Write("(NYSE: SMF)") end if %> are now growing units at a single-digit percentage rate. When Costco announced fiscal 1998 results ending in August, it expected to open just 4-5 new units before Christmas. For a chain 280 units strong, where a good deal of time is spent closing failed units to relocate elsewhere, the snail's pace growth rate should alarm anyone bidding the stock to almost thirty times earnings.

Where is the future? Sure, both Sam's Club and Costco are trying to nurture international expansion in the face of a saturated domestic market, but as Gap <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GPS)") else Response.Write("(NYSE: GPS)") end if %> and Toys R Us <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TOY)") else Response.Write("(NYSE: TOY)") end if %> have shown, growing a North American retail concept overseas is no easy task.

My respect for Yi-Hsin runs as long as the depressingly slow checkout lines of your neighborhood Costco. That is why it puzzles me how someone like herself, who is so quick to tell me Starbucks <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SBUX)") else Response.Write("(Nasdaq: SBUX)") end if %> and Rainforest Cafe <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RAIN)") else Response.Write("(Nasdaq: RAIN)") end if %> are fads, can't recognize the novelty as long as she remains a card-carrying member.

Just last month Yi-Hsin celebrated her first anniversary as a Costco shopper. Oh, youth! I know it's a special moment -- like the embryonic glow of receiving a laminated Spice Girls fan club membership card. I'm sure she still wears a smile as she rolls her wide-load industrial-strength cart over concrete slab aisles, wondering whether buying frozen chicken cordon blue by the truckload is prudent as she admires the exposed beams overhead. There is an amateurish lure to slumming it. Avast ye creature comforts. You see, I've been there. Yi-Hsin has called me a closet Costco shopper in discussions before we set pen to paper here (or hand to keys, as the case may be). She is partly right. About five years ago I had a Costco card in my wallet. No more. It was fun for awhile. However, logic wears away the neophyte enthusiasm.

Traditional supermarkets have already figured out that laying out select mondo-sized offerings are attractive purchases to some shoppers. Aesthetically superior to the outhouse on steroids architecture of Costco, supermarkets are now providing the same wares in a more efficient setting. So as competitors have grown beyond the hesitant pioneers like Wal-Mart and BJ's to the supermarket giants, Costco is going to get squeezed out by the grocers whose surprising flexibility to cater to home meal replacement put away Boston Chicken <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BOSTQ)") else Response.Write("(Nasdaq: BOSTQ)") end if %>.

You don't believe me? Let's look at the numbers. Sales over this past year rose a scant 11%. Earnings, coming off a charge-ridden 1997, naturally improved substantially, but now that the company is on an even playing field with sleepy growth plans, earnings will probably track the anemic sales growth from here on out in the near term. In the long run, given the burgeoning competition in non-traditional formats, things may get even worse as the margins contract.

Heather (TMF NoClue) has already told me, kiddingly, that knocking Costco will cost me a few TMF friendships. That's fine. It's not as if I have some excess groceries I need to sublet to my Foolish brethren. But if this is true, if there is a nerve that gets hit, what better proof can there be that this is in fact a fad. A pet rock that cards you at the door. A hula hoop that serves up free samples. A warehouse club that knows where the off switch rests.

Next: The Bull Responds