Yes, Costco (and Other Retailers) Can Compete With Amazon

NEW YORK (TheStreet) -- This week, TheStreet's Jim Cramer took Costco (COST) shares out of his charitable trust because he doesn't think anyone can get retail margins with Amazon (AMZN) so anxious to grow and willing to cut prices to the bone in order to do so.

I think he may be misreading the situation.

First, Amazon does have margin. If you are addicted to, say, those fancy dried mandarin oranges made by SunOpta's (STKL) Nature's Finest unit, Amazon isn't selling it to you at cost. It's making money on the deal.

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You know who else is making money on those oranges? An outfit called Ducky's Shoppe, which uses Amazon for its marketing and fulfillment. It has 44 pages of Amazon merchandise, most of it in small lots. Toys, food, books and branded merchandise.

If it were a physical store, it would be a hole-in-the-wall on some dirty city street. Its ability to source things people might want and sell them through Amazon means it has a retail business that works.

Thousands of companies piggyback on Amazon in this way. Amazon can handle their sales taxes and credit cards, plus their marketing and deliveries. And it's not just people selling goods who depend on the company. There are a host of companies reselling  Amazon Web Services, a cloud-computing service, as well.

My guess is that IBM (IBM) , Hewlett-Packard (HPQ) and Rackspace (RAX) have a lot more to worry about from Amazon than Costco does. Those are the companies that are losing all their margin to Amazon, not Costco. 

How is Costco doing? Not badly. Sales this year are running about 4% ahead of last year's $105 billion, and it brought less than 2% of those sales to the net income line for its most recent quarter. Amazon's sales for its last four quarters, by the way, come to $81.82 billion. That's less.

Lots of retailers continue to do well by understanding their niches and sticking to their knitting. Kroger (KR) , for instance, is almost as big as Costco and is competing more directly with Walmart (WMT) , turning some of its grocery stores into the equivalent of supercenters. And Walmart is more than six times bigger than Amazon is in sales.

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Amazon isn't swallowing the world. It's building data centers and warehouses to compete around the world, about $1 billion in new capital investment each quarter. It recently committed $2 billion in capital to India to compete with online mega-store Flipkart. It has opened a 'China' region for its cloud-computing business.

The point is, if I need eggs and milk, I go to Kroger. If I need a car-sized lot of toilet paper, I go to Costco, and if I need a hammer I still go to the Home Depot (HD) .

My wife isn't buying her outfits at Amazon, either. Retailers can compete with Amazon, and they can also make money by joining it. Either way, they still make money. That's not about to change any time soon.

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At the time of publication, the author owned shares of Amazon and Costco.  

Follow @DanaBlankenhorn

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

TheStreet Ratings team rates COSTCO WHOLESALE CORP as a Buy with a ratings score of A. TheStreet Ratings Team has this to say about their recommendation:

"We rate COSTCO WHOLESALE CORP (COST) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its revenue growth, increase in net income, largely solid financial position with reasonable debt levels by most measures, good cash flow from operations and growth in earnings per share. We feel these strengths outweigh the fact that the company has had lackluster performance in the stock itself."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The revenue growth came in higher than the industry average of 3.4%. Since the same quarter one year prior, revenues slightly increased by 7.1%. This growth in revenue appears to have trickled down to the company's bottom line, improving the earnings per share.
  • The net income growth from the same quarter one year ago has exceeded that of the S&P 500 and the Food & Staples Retailing industry average. The net income increased by 3.0% when compared to the same quarter one year prior, going from $459.00 million to $473.00 million.
  • Net operating cash flow has increased to $1,490.00 million or 10.45% when compared to the same quarter last year. Despite an increase in cash flow, COSTCO WHOLESALE CORP's average is still marginally south of the industry average growth rate of 11.54%.
  • The current debt-to-equity ratio, 0.42, is low and is below the industry average, implying that there has been successful management of debt levels. Despite the fact that COST's debt-to-equity ratio is low, the quick ratio, which is currently 0.57, displays a potential problem in covering short-term cash needs.
  • COSTCO WHOLESALE CORP's earnings per share improvement from the most recent quarter was slightly positive. The company has demonstrated a pattern of positive earnings per share growth over the past two years. However, we anticipate underperformance relative to this pattern in the coming year. During the past fiscal year, COSTCO WHOLESALE CORP increased its bottom line by earning $4.63 versus $3.90 in the prior year. For the next year, the market is expecting a contraction of 0.8% in earnings ($4.60 versus $4.63).

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