The Retail Playbook – Costco, Dollar General, TJX and Ross Stores

Ever wondered why certain retail companies thrive while some falter? In this article, we will look at a few USA-listed companies as examples. In the future, we can explore Japanese-listed (Don Quijote, Seria), Malaysia-listed (Padini), Australia-listed (Lovisa and Smiggle under Premier Investments).

This post is inspired by Wallace. Let’s start!

TJX and Ross Stores are apparel companies.

Costco is a supermarket. One of its shareholders is Warren Buffett’s business partner, Charlie Munger.

Dollar General sells general merchandise. Pat Dorsey owns some shares.

What are the common competitive advantages behind these companies? They thrive despite the “Amazon” effect.

It is common fact that Amazon turned up the heat on many offline retail shops. Those who could not take the heat, they lost their customers. Some of Amazon’s victims are Macy’s, Kmart, J C Penney, and Sears. Some talked about it being a retail apocalypse as sales suffer and stores start to close. Their victims operate in the urban areas.

I am going to highlight three companies and state briefly on what I think their strengths are.

#1 Costco Wholesale (NASDAQ:COST)

Costco is the second largest retailer in the world after Walmart. It sells general merchandise and groceries. Their signature brand is Kirkland Signature. It has over 700 warehouses all over the world, doing well in overseas. They sell in bulk and focuses on a limited number of brands. This keeps their inventory moving rapidly.

(Kirkland Signature branded potato chips)

With a 97.9b market capitalisation, it bucks the trend by opening more hypermarkets. Its cash flow from operations grew at a CAGR of 18.3% for the past 4 years. It sells things cheaply, it marks up its merchandise lower than Walmart, as a direct result, it has a gross profit margin of 13.1%. But wait… its net profit margin is at 2.1%? That’s right, Costco played the role of a discounter better than Walmart.

By selling their goods so cheap, its business model found favour among its customers. Many of them became die-hard fans of Costco and they bought a truckload of items each time. By using volume to compensate for its low margins, Costco is still able to report a decent Return on Equity of 24.6%.

Credit: businesskorea.co.kr

Costco decided to play the game differently. Instead of choosing to earn from selling merchandise, it innovated by earning from memberships.

To shop at Costco, you’ll need a membership. Typically, a basic membership could cost $60. From a business perspective, the money flows down as profits since there are no actual costs except for the cost of making the card.

By paying $60, each customer is compelled to shop more since they would like to “stretch” the value of $60. It’s an absolute win-win because customers get cheaper prices and the company earns a direct profit and repeated purchases. Costco has roughly >50 million members.

A flywheel effect is created.

Low prices bring in more memberships.

More membership brings more sales.

More sales bring in leverage which allows Costco to buy cheaper from its suppliers.

In return, Costco can push down the prices for its customers.

If you ever been to a Costco, it is like a wonderland Disney maze where you will find things you never knew you needed and make impulse purchases because of its screaming value. While waiting for you to shop, your family could wait at their cafeteria and be served delicious pizzas or hot dogs at incredible prices. I’ve even heard about individuals who buy memberships just to gain access to its cafeteria food. The mom and sisters can shop at the glasses shop, the dad refuels its gas and the sons get the job of doing grocery shopping… all these under one roof. You can spend the whole day there and not feel bored (PS: you’ll buy more subconsciously)

Costco also utilised a strategy where they move items/labels around. Although I did not verify, there is also a lack of labels for shelves in some instances. This forces customers to be exposed to a greater variety of products and increase their purchases along the way.

Credits: Costco Investor Relations

Just by playing this strategy correctly, Costco grew 249x from 1982 to 2018.

Read more at https://www.dropbox.com/s/7hohqj3rl2uv43p/COSTCO%20Deck.pdf?dl=0

#2 Ross Stores (NASDAQ:ROST)

Ross Stores focuses on off-price retail apparel and home fashion. Their two brands are “Ross Dress for Less” and “dd’s DISCOUNTS”. They have over 1,000 locations in more than 35 states.

In their store, you’ll see this sentence “experience the treasure hunt“. People love to shop physically because it is an in-store experience which is not possible online.

Their current CEO is Barbara Rentler who started her tenure in 2014. Prior to that, she was the Chief Merchandising Officer. She joined the company in 1986. She is known within the company as a gifted leader who knows how to find great bargains to stock in their stores. Despite the competition from Macy’s and Nordstrom, Ross Stores is not fazed. It stood with its strategy of bringing great value on items.

Again, Ross Stores are very similar to Costco. From their website, “we operate our off-price businesses in a way that keeps costs low so we can pass the savings to our customers. With this model, we’ve been able to grow and open new stores across the country. In fact, our sales growth has outpaced traditional retailers for the past three years.”

The numbers speak for itself. Click on the image to view the financials. Its revenue grew at an unstoppable pace from FY2008 to latest trailing twelve months. The more impressive feat was their operating margins, it moved from 7.6% to 14.5%. This demonstrated greater efficiency in managing the business costs. A company that is more profitable makes shareholders happier and it provides a good reason for the share price increase.

Ross focuses on fashion apparel where the majority of the customers still prefer trying them on before a purchase. Ross does not have a strong e-commerce and I believe it is intentional. They offer clothes that are discounted at 20-60%, they are purchased from fashion brands who overproduced their inventory.  Consumers are looking for bargains, and Ross Stores is their answer. Going against the trend, Ross Stores opted for a no-frilled approach in stores decor as well.

A BusinessInsider writer went to a store and wrote an article here.

Sometimes, to validate whether Ross is really doing well, I like to perform some checks on social media platforms such as Facebook, Instagram, and Twitter. Despite the terrible state of the store, customers seem to love the company a lot. A bit of oxymoron but it works so far.

#3 Dollar General (NYSE:DG)

DG is a discount retailer, same as Costco and Ross Stores, it sells general merchandises such as wine, snacks, over-the-counter medicines, home office supplies, storage containers, frames, apparel and other merchandise. They have over 15,000 stores. Its latest market capitalisation is around $28 billion.

Credit: Nashville Business Journal

The current CEO is Todd Vasos. Before that, he was Chief Operating Officer. He was also the Chief Merchandising Officer at some point of his career. A very similar path as Barbara Rentler of Ross Stores. Vasos focuses on training a team of strong store managers because they are the ones who will take care of the stores.

They are bucking the trend by opening more stores as their peers are closing down more stores. I think, income inequality has been on the rise in many parts of the world… especially USA. This prompted more middle class to stretch their dollars further, hence the kind of customers Dollar General is serving, is growing bigger. The company has a culture of serving others and taking care of underserved customers.  It’s about creating the value for communities. I do think, during crisis periods, DG might outperform.

They are looking at smaller rural areas to expand. They went to towns where no one went. These are the areas where Amazon is less likely to go because its e-commerce logistics may not have the capabilities to deliver so far or it does not make sense economically. Imagine making a trip of 30-40km to deliver fresh groceries to a customer, the cost of delivery might be more than the profits.

As long as they are focusing on providing quality at great prices, I do think DG has a long runway for growth. There is still a segment of customers who crave to develop personal relationships with the store managers, especially in communities. They would opt to shop physically as compared to online.

There are even Youtube videos of passionate shoppers who will plan their purchases based on the coupons available!

DG has an ROE of 26.2%, net debt to equity of 41.4%, and EV/CFO of 16.5x.

Given a choice, out of 3, I would choose Costco because it is in the consumer staples space (more stable) and its overseas expansion is kicking off.

Many investors would deem the retail sector as a very dangerous place to be in, especially when Amazon is eating up market share and destroying several competitors that stood its way. However, there is a way to win in this sector. Focus on providing the best prices, variety, and best in-store experiences. Get customers excited to visit your stores.

Here are some key things to analyze:

• Are they competing in the cities or outskirts? Amazon can’t be everywhere.
• Are they customer-centric? By putting their customers as the first priority, giving them great deals, their customers will love them back and they will be compensated by the volumes of purchases. Focus on the middle-class.
• Are they thinking about margins or volumes? Focus on delivering great value.
• Are they differentiated or are they competing in the same space as many others?
• Who is their management? Did they start from the basics and do they understand merchandise? How long have they been in this industry? Without the correct selection of merchandise in the stores, customers would not shop.
• Are their inventories influenced by fashion or they are considered stable essentials such as groceries?

At the end of the day, give your customers the best value, the best variety, move your inventories fast, build a genuine relationship with your customers, listen to them, and ALWAYS find ways to lower down your cost structure. It’s back to the fundamentals.

That’s how you play the retail game.

If you’re in the retail space or have a view on this industry, feel free to leave a comment or email me at kelvesy@gmail.com.