For decades, it seemed as if consumers were on an all-out shopping spree, fueling massive growth in the retail sector.
But now that run is over.
The recession forced the nation’s biggest retailers, like Macy’s andJ.C. Penney, to shutter up stores and halt their plans for expansion. And many others, like Circuit City and Linens n’ Things, declared bankruptcy.
This news may sound grim… but Americans haven’t completely stopped spending. In fact, a handful of retailersactually grew revenues during this difficult retail environment.
Yet when most people think of recession-proof stocks, Wal-Mart is usually the first that comes to mind. It’s definitely a favorite of the financial media. Kiplinger’s and Forbes both point out Wal-Mart’s ability to hand investors steady gains throughout deep recessions.
But be warned! Wal-Mart is NOT the best stock you can buy right now.
That’s because it’s one of the most widely held stocks in the world. It would have to pack on another $250 billion in market cap to double your investment — a monumental feat, to be sure.
But imagine if you could invest in two businesses very similar to Wal-Mart — that attract more customers in tough economic times… That crank out cash no matter how bad things get… And that have market caps that are just a fraction of Wal-Mart’s…
One is a brick-and-mortar competitor… the other is an e-commerce business that Fast Company calls “The New Wal-Mart.”
So let’s dive in and find out what makes these companies so special. And why David and Tom Gardner — co-founders of The Motley Fool and co-advisors of the Motley Fool Stock Advisor investment newsletter — believe these are excellent long-term retail holdings.
Put customers first and success will follow
That’s what motivated the founder of our first company — and as you’ll realize, it’s what has its stock price set to soar. Although the founder recently retired, we expect his successor to do the same. With bulldog tenacity, this company keeps prices low — making sure customers come back time after time.
The company is so focused on creating bargains, markups never exceed 15% on any product — pressuring suppliers to sell for cheap. It’s not easy, but “that’s why they call it work,” he says.
Call it what you will, but it almost guarantees healthy cash generation and consistent growth! In just 30 years it’s become the seventh-largest retailer in the world.
In fact, this company brought in more than $103 billion in sales — in the past 12 months alone!
These kinds of results led to a No.1 “Specialty Retailer” ranking in Fortune magazine. It was also recently named the “20th most admired company in the world.”
You’re probably familiar with this company and maybe even its founder, Jim Sinegal. You may even be among his stores’ 67.4 million members. But you might not realize just how big the stock’s upside is.
Frankly, we’ve long considered Costco Wholesale [Nasdaq: COST] one of the best-run companies around. Its stock hasn’t always been cheap, but the company is still a long-term favorite.
Because what Costco sells is big value. Each of the club warehouse retailer’s 627 no-frills stores is as big as two and a half football fields with the end zones — enabling each location to carry about 4,000 items. Many of those are in bulk. So if you need a 48-pack of toilet paper or 15 pounds of rib eye, Costco has you covered. Its wide variety of merchandise includes laundry detergent, tires, diamond rings, electronics, and tubs of trail mix big enough to sustain a Boy Scout camp for a week.
Costco makes sure shelves are stocked with big items carrying small price tags. Though this limits the profit it can make off merchandise, the primary focus is providing Costco’s members with great value. And the company keeps things interesting for them by constantly stocking the shelves with new items, a concept Sinegal called the “treasure hunt.”
More than 67 million people in 37 million households belong to Costco. And its membership base is a big part of its success. About 75% of Costco’s operating income comes from the $55 annual household membership fee, which allows members to shop at any of Costco’s stores or on its website.
And customers keep coming back for more. The renewal rate for membership approaches 90%, no doubt thanks to the company’s refusal to substantially mark up merchandise. Costco is working on expanding its membership base and hopes to open hundreds more warehouses — many in international markets, where value shoppers abound.
For some companies, new stores put a dent in the bottom line. Not so with Costco. With almost no exceptions, every store the company opens is immediately profitable. And each has a track record of becoming more profitable every year of operation.
How is this possible?
In part, it’s because Costco has an exceptional cash conversion cycle. That’s a little formula that measures, in days, how quickly a company can buy inventory, get it on the shelves, and sell it, thus converting it to cash. Costco turns over its entire inventory 12 times a year (roughly once a month!) — allowing it to sell merchandise even before it has to pay its suppliers for it.
This enables the company to buy some of its inventory on the vendors’ payment terms instead of using its working capital. Costco’s outstanding cash conversion cycle is less than three days. By comparison, a more traditional retailer like Macy’s usually takes at least 30 days to convert its inventory to cash.
This business model produces significant free cash flow — about $1.5 billion during the past twelve months. And this has enabled Costco to build a solid balance sheet, with $5.7 billion in cash and only $4.9 billion in debt.
Even though it’s now trading above $100 a share, we’re still convinced it could be worth more. Meaning investors who snap up shares now will continue to be rewarded.
No matter how we run the numbers, now is time to make a Costco run!