A Stock Analyst Just Put Out a Scathing Open Letter to Costco Brass -- Here's What She Said
Costco in focus.

In lieu of a traditional analyst note, Barclays analyst Karen Short sent an unusual open letter to Costco Wholesale Corp.'s (COST) management on Thursday, July 13, warning the company that it needs to address investors' long-term concerns about the implications of Amazon.com Inc.'s (AMZN) $13.7 billion acquisition of Whole Foods Market Inc. (WFM) .

While Costco achieved "very impressive June comps," the results were met with an "uninspiring reaction," and Costco's stock has significantly lagged the S&P 500 since the deal was announced.

"Given the potential that long-term concerns will overshadow near-term results, the only solution near term, in our view, is to convince and communicate to investors that you have a real and defensible strategy in an ever changing world," she wrote.

Here are Short's suggestions for a potential long-term "real and defensible strategy" Costco could pursue.

1. Consider an e-commerce acquisition - several options come to mind. An e-commerce wholesale retailer of consumables - regardless of whether it has a membership fee - would be a great fit, in our view.

2. Evaluate options to meet the demand for click and collect - potentially via dedicated, separate facilities for pick up only. You have historically resisted click and collect given a lack of space in your store resulting from strong productivity (~$1,200 in sales per square foot vs. Sam's Club at ~$640, including fuel and membership fees) as well as separate costs to operate click and collect. Sam's Club shoppers have shown they enjoy the convenience offered by this service since club stores are large, often difficult to navigate, and take a long time to shop. We believe you should open dedicated pick-up only facilities for click and collect across the U.S. and believe these facilities would solve for space constraints inside the warehouses and in the parking lots. It would likely even result in incremental memberships, in our view.

3. Evaluate a joint venture with Ocado for home delivery of food. As a reminder, Ocado is a UK based online shopping and fulfillment company that operates its own business and those of its commercial partners. The company has publicly broadcasted its intentions to partner with international (including the U.S.) food retailers...We believe you should contemplate forming a joint venture with Ocado because of its unique end-to-end operating solution for online grocery retail based on its proprietary technology and intellectual property. In our opinion, if you offered home delivery for food - the sale would be incremental, not cannibalizing. While e-commerce price points would be higher than bricks and mortar - we believe the math works (if price points are higher for food-at-home delivery).
To simplify how a relationship with Ocado would work: Costco would provide Ocado with an empty turn-key facility. Ocado then integrates its operating infrastructure in the facility to enable an e-commerce solution...

4. Meaningfully accelerate non-food e-commerce efforts. If this means hiring an external army of Silicon Valley techies - then so be it. You need external, IT-related expertise to improve service, develop algorithms, and offer more "base technologies" that we believe are increasingly necessary to compete effectively. Just as all retailers now have technologies that make shopping more convenient - such as electronic registers or UPC scanners - we view a robust e-commerce offering (e.g. mobile, click and collect, etc.) and a high degree of personalization (e.g. targeted recommendations, pre-populating frequently purchased items on an online interface, product subscriptions, etc.) as minimum requirements for retailers in the new world. While these may have seemed a "nice to have" service to offer customers historically, we believe the world is moving in a direction where these will be a base expectation of a growing group of shoppers.

Lastly,

5. Seriously contemplate making a counter bid for WFM to keep the asset out of AMZN's hands...By our math, we believe you can offer substantially more than AMZN for WFM and still have it be accretive (excluding purchase adjustments). As high as a $60 stock price would be marginally accretive with a 50% debt/50% equity split as shown in the chart below. Given the current stock price, it may not be an advantageous time to issue equity, however. We believe the deal could be done on an all cash basis and generate mid to high single-digit accretion to cash EPS given COST's minimal leverage and large net cash position.

Costco share's rose 1.2% to $153.50 by Thursday's close.

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