At Berkshire’s virtual shareholder meeting last month, Buffett signaled that the Covid-19 pandemic hasn’t afforded him deal opportunities at bargain-basement prices the way past economic meltdowns have. Despite the nationwide shutdowns that are just starting to lift and a soaring unemployment rate, the S&P 500 Index is only 8% off its February all-time high. That’s partly due to aggressive actions taken by the Federal Reserve to mitigate the crisis, though one can’t deny that there exists an astonishing disconnect between stock prices and the economic realities of many Americans right now.
Costco wouldn’t be a typical crisis-era bet for Buffett in this regard. The shares are up, not down, this year and its operations have carried on throughout the pandemic. Zoom, Netflix, TikTok, Costco — the retailer is right up there with those services that have become centerpieces of the stay-at-home recession.
But in so many other ways a Costco deal would still be classic Buffett. For starters, Buffett already likes Costco. Berkshire has owned the stock for two decades; its 1% stake is valued at about $1.3 billion currently. Buffett’s business partner Charlie Munger, the 96-year-old vice chairman of Berkshire Hathaway, also sits on Costco’s board. Last year, Buffett even publicly marveled at Costco’s in-house Kirkland brand, which at that point had $39 billion of annual sales. “Here’s somebody like Costco, establishes a brand called Kirkland and it’s doing $39 billion — more than virtually any food company,” including Kraft Heinz Co., he said. Berkshire is Kraft Heinz’s largest shareholder.
Costco has proven during this crisis that it has a durable brand and a wide competitive moat, two of the key attributes Buffett looks for. More than 90% of Costco’s U.S. club members renew, and globally the rate is nearly as high at 88%. Those warehouse memberships are a predictable source of cash flow, almost akin to Berkshire’s insurance float that Buffett uses to invest. While the majority of Costco’s 787 warehouse clubs are in the U.S. and Canada, it does have locations in Mexico, the U.K., Japan, South Korea, Taiwan and Australia. It’s also expanding in China, offering Buffett exposure to the country’s growing middle class.
Costco’s same-store sales have risen 6.5% on average for the last 10 quarters, topping other U.S. mass retailers including Walmart Inc., the parent of Sam’s Club. Costco also generated more than $1,300 of sales per square foot in fiscal 2019 — more than any of its peers.
The share price has gotten a bump from all the panic-shopping, and at 34 times earnings, Costco’s valuation certainly isn’t what Buffett would call cheap. But Costco should continue to fare well in a post-virus America, especially if it leads some residents to ditch cities for suburbs and spend more time at home. After the meat and toilet paper shortages, more shoppers may even turn to bulk-buying to be better prepared for future lockdowns or shortages.
The biggest hurdle to a takeover is that Costco’s market value is $137 billion — precisely the amount of cash Berkshire has available. Berkshire’s last major acquisition was Precision Castparts, a maker of airplane engine parts, for $37 billion in 2016. After years spent searching for his next target, Buffett signaled recently that his hunt is on hold, suggesting that he thinks the crisis could still get worse before it gets better. “The cash position isn’t that huge when I look at the worst-case possibilities,” he told a stunned audience last month that tuned into the livestreamed annual meeting expecting to hear something a little more upbeat or at least hopeful from the Oracle of Omaha.(1)
Berkshire could simply increase its stake in Costco, a stable holding that pays a 70-cent quarterly dividend. But it wasn’t all that long ago that Buffett spoke of the possibility of an acquisition Costco’s size. “If a $100 billion deal came along that Charlie [Munger] and I really liked, we’d get it done,” he said in May 2018. With Buffett set to turn 90 in August, it would be uncharacteristic to not want to do one last splashy transaction.
It also wouldn’t be the first time Berkshire acquired one of its stock holdings. Berkshire owned shares in Precision Castparts before that deal. It also took a stake in the BNSF railroad in 2007 and kept adding to that position until it eventually purchased the whole company. Berkshire’s ownership of Geico even dates back to the 1950s when Buffett first bought shares and as a curious young investor began a serendipitous friendship with the insurer’s former CEO, Lorimer Davidson, as Buffett often retells it.
Whether as a takeover candidate or stock pick, Buffett’s best option may be right under his nose.
(1) One well-known shareholder, Bill Ackman’s Pershing Square Capital Management, even exited its Berkshire position, deciding itcan find worthwhile investing opportunities faster than Berkshire can at this rate.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Tara Lachapelle is a Bloomberg Opinion columnist covering the business of entertainment and telecommunications, as well as broader deals. She previously wrote an M&A column for Bloomberg News.