Company Updates: Costco Wholesale and Cintas
- By Christopher De Sousa, CIM® | Portfolio Manager
- 4 Min Read
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CINTAS
Cintas is a leading provider of corporate identity uniforms, first aid and safety products, and cleaning services and supplies. Cintas serves over 1 million businesses of all types and sizes primarily in the U.S., as well as Canada and Latin America. We see a large runway for growth at Cintas considering there are over 16 million business in North America that could be utilizing the company’s products and services. Cintas enjoys a regional and local monopoly, fortified by unique competitive advantages such as technology and economies of scale derived from route density. These advantages present significant challenges for competitors, primarily mom-and-pop shops, to replicate or compete effectively.
In the latest quarter, Cintas reported sales and earnings growth of 10% and 22%, respectively. Sales growth benefited from strong volume growth, new business wins, and further penetration and cross-selling among the existing customer base. Building strong relationships and earning the trust of a customer enables Cintas to not only sell uniforms to that business, but also allows the sales rep to cross-sell restroom supplies, entrance mats, and cleaning services. We think entering new markets and further partnering with its existing customer base will continue to be instrumental to the company’s ability to grow organic revenue growth in the mid-to high-single digits and double-digit earnings growth over the next five years.
Cintas earned an operating profit margin of 21.6%, an improvement from 20.6% in the same quarter a year ago. Margin performance widened from a combination of technology-driven operational savings and efficiencies across each business segment. We believe that as Cintas expands the existing route and service network, operating costs including fuel expenses should decrease as a percentage of revenue per delivery route. We expect to see continuing operating leverage through scale and greater route density, leading to higher margin revenue per delivery route over time. Cintas currently serves over 11,500 local delivery routes across 330 cities.
Cintas is a boring business with exceptional fundamentals and stellar management execution. Cintas has grown sales and profits in 52 of the last 54 years—the only exception being the Great Recession.
COSTCO WHOLESALE
Costco Wholesale opened its first membership warehouse in 1983 in Seattle, Washington. Costco is now the world’s third-largest retailer, behind Walmart and Amazon, and operates 874 warehouses worldwide with revenues exceeding $240 billion. Costco offers its members low prices on a limited selection of national brands, selected private labels, and in-house brands (i.e., Kirkland) across a wide range of categories while generating high sales volumes and rapid inventory turnover. There are over 73.4 million paid household members (grew 7.8% y/y in the latest quarter) and 132 million cardholders (+7.3% y/y). In Canada and the U.S., the membership renewal rate is 92.9%—a record high.
Costco has two membership classes: Gold Star ($60) and Executive ($120). Executive members represent ~46% of paid members and ~73% of global sales and growing each quarter. As many of you know, the rise of online shopping has led to fewer people visiting physical stores. However, Costco stands as an exception. High volumes of customers continue to visit Costco warehouses week in and week out. Retail foot traffic in the U.S. (+4.3%) and globally (+5.3%) remains strong and some of the best we are seeing in the retail industry. In the latest quarter, Costco reported sales and earnings growth of 5.7% and 18.8%, respectively.
Costco is experiencing a recovery in the discretionary merchandise category. Sales of big-ticket items such as appliances are growing over 20% whereas the industry is flat. This is promising as discretionary items carry higher margins, and in turn, would have an outsized impact on the company’s profits. Costco’s e-commerce business, which represents just ~6% of total sales, has been a standout performer, rising 18.2%. Costco Logistics set a record by delivering over a million packages, an increase of 28%. We believe Costco’s e-commerce business is still in its early stages, with a long runway for growth.
Costco operates a simple yet effective business model: set prices at a level that encourages bulk buying while simultaneously generating a consistent flow of membership revenues. Costco purchases most of its goods directly from manufacturers, often selling these items before its required to pay for them. Each Costco warehouse carries fewer than 4,000 SKUs, a number significantly lower than other retailers such as Walmart and Target. This focused approach and quick inventory turnover gives Costco greater bargaining power over suppliers, enabling it to negotiate lower prices due to its large and frequent purchasing volumes.
Costco has managed to gain a significant market share over time attributable to its superior value proposition and the loyalty of its customers. We think Costco has a large opportunity set to expand its warehouse base internationally. We see China being a large opportunity as Costco only operates six warehouses, compared to its largest competitor (Sam’s Club) at 48 stores. In addition, Costco could be raising membership prices sooner rather than later. This would lead to an immediate bump to net profits. Historically, Costco has raised membership prices every five years. The previous price hike was in 2017.
Like Cintas, we think Costco is a boring business with exceptional fundamentals and stellar management execution.