On today's edition of Good Buy or Goodbye, Tematica Research chief investment officer Chris Versace joins Julie Hyman to discuss his top picks as consumers struggle with the rising cost of food.
Versace points to Costco (COST) as a buying opportunity as consumers cut back on dining out. He explains that the retail giant is "extremely well positioned" since about 54% of its product revenue comes from fresh food and sundries. He adds that Costco is taking wallet share as it continues to deliver value to consumers, pointing to its $1.50 hot dogs as one area of consistent value. The strategist also emphasizes that Costco has yet to raise its membership fee. When the price increase finally hits, he notes that consumers will likely continue paying their memberships, allowing the company to generate more revenue.
On the other hand, Versace is bearish on McDonald's (MCD). He reiterates that consumers are not eating out as much as inflation continues to pressure their household budgets and notes that the fast food giant is "no longer the cheap alternative." Despite rolling out value meals, Versace is unsure whether McDonald's can drive its margins higher over time. In addition, wage pressures have created headwinds for McDonald's in terms of hiring and maintaining its workforce. He notes that the company will have to make significant investments to overcome this issue and boost productivity.
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This post was written by Melanie Riehl
Video Transcript
It's a big noise.
The universe of stocks out there.
Welcome to, goodbye or goodbye.
Our goal to help cut through that noise to navigate the best moves for your portfolio.
Today, we're tracking the shift in consumer spending on food.
I'm here with Medical research Chief Investment Officer Chris for back with us.
Good to see you.
Good to see you and your goodbye is actually been a sort of a popular one here on.
Goodbye.
Goodbye.
And that is Costco.
It's very popular on the finance platform as well as she is already up more than 60% over the past year.
So let's get to why you like it here.
And we are seeing we've seen some shifts like throughout the pandemic.
Obviously, people were eating at home then then they went back out again.
Now they're going back home.
It seems like.
Yeah, absolutely.
You know, whether or not we measure up recent retail sales reports or we look at some of the survey data out there.
People are, you know, feeling the pinch of continued higher prices and they're shifting back home.
Uh probably the best data point I can give you on this Julie is something new from the Philly fed.
You know, they put out all these different surveys and it shows that about 43% of consumers surveyed are clamping down on discretionary spending, particularly eating out.
So I, I think this is a great way to play it.
And I, I say this because most people don't think about this.
Costco gets about 54% of its um, product revenue from uh fresh foods food in sundries.
It's so it's extremely well positioned.
It's also the largest seller of beef in the world.
But that's beside the point.
Wow, I did not know that.
Ok, so there you go.
So if people are, people aren't going out to eat a steak, they wanna save some money, they're throwing that steak on the grill at home.
Um Secondly, you think they're taking consumer wallet share and this is sort of part and parcel, right?
Because they are seen as a value within this whole chain.
There is no debate about this.
So, you know, the great thing about Costco is it reports monthly sales, right?
So you can take a look at what their comp sales are.
You could take a look at what they are on an adjusted basis.
Then all you have to do is measure them up against what we see from the commerce department with the monthly retail sales report.
And when you do this, there's no question, Costco is taking wallet here.
Interesting and why Well, how are they doing that?
Is it the value proposition or are there other things going on?
I think it's the value proposition, uh, primarily, you know, I would say I'm going there for the hot dog at a dollar 50 but it's, it's more of extending the disposable dollars that you do have.
And, you know, if you've been to Costco, you know, that it's, it's extremely hard to beat.
They've done a great job.
Like we kind of talked about leaning into grocery, just size up what Kroger said today against what we see with Costco.
And again, they're clearly taking share, ok?
And then finally, they haven't raised the fee yet.
Everybody's waiting for it to happen, the membership fee to go higher.
Yeah, I mean, they have roughly 74 75 million, you know, memberships out there.
Uh at some point they are going to raise this, you know, whether it's $5.10 dollars, you know, to you and me and everybody else who shops there, no big deal, but for them across the entire membership, that's a huge number.
And the key here is that this high margin membership fee, revenue stream is about 50 depending on the quarter, 60% of net income.
So it, it's a real differentiator for Costco, but at the same time, they continue to grow the warehouse footprint, fueling continued growth in the membership fee.
So let's get to what could potentially go wrong with Costco one is they decide not to raise the membership fee anytime soon.
And secondly, there's the other piece of what you talked about that they don't expand that the warehouse space as much as anticipated.
I 100%.
Although this one I would say is very low if only because the management team over the last several conference calls when they report their earnings have said, yeah, it's just a matter of time that, you know, we will do this.
And I think when we get it, you'll see earnings expectations move higher price targets, move higher as well.
Got you.
And what about the, the second one?
Well, I mean, look, if we start to see interest rates come down, you know, I'm thinking one, rate fed rate cut later this year, a couple more next year.
You know, that's gonna help improve their hurdle rates.
I do think that there's room for them continue to and not only in the US Canada call it North America, but also outside.
You know, they've only got a handful of locations in China and other um, territories that you could see even greater penetration.
All right.
So let's get to the stock.
You don't like as much here in the food area.
We're talking about mcdonald's, these shares are down about 10 11% over the past year.
So it's sort of the converse or inverse if you will of Costco that people are not eating fast food as much.
Right.
I mean, and it's two parts.
Right.
So, as, as we talked about people are not eating out as much.
They're feeling that pinch.
But at the same time, let's take a look at what we've seen for price increases in fast food where in some cases it's almost on par with fast casual.
Right.
A Chipotle or something like that.
It's no longer the cheap alternative.
Interesting.
Even though, I mean, they have, they have rolled out the value meals though.
I mean, now there's sort of a value meal war going on.
You think that's gonna be enough well, to begin with?
There's the, you know, what is it gonna cost them on the margin side?
And at the same time there's the competitive response.
So, how long does this go on for?
That's my bigger concern.
Right.
You know, leading with price good in the short term, but it's very hard to kind of draw drive those margins higher over time if you're leading on price.
Well, especially as they still have wage pressures for the, I mean, wages are not going down, certainly for fast food workers.
And so the margins are, they don't have a lot of flexibility, I guess on margins if they're offering these value meals.
Well, so there, there's a couple of things here.
Right.
So you're 100% correct that wages are going higher.
Take a look at what's happening in California.
That's really gonna hurt them.
I think Brian Sazi posted something about that yesterday.
Um, but at the same time, we could look at AD PS monthly, uh, pay change data, you know, job stayers, 5% year over year, pretty consistent.
The last several months, job changers even higher.
But you talk to some of these hiring managers at local, uh, mcdonald's or other fast foods, still very tough to find people because of what they want in terms of wages.
And then at the same time, we've got, we've got other dynamics at play here where if these companies want to overcome this productivity issue, they have to invest, whether it's A I robotics, what have you.
So you, you're having margin pressure but you've got to invest at the same time.
Something's got to give.
Yeah.
Interesting.
OK.
So what could go right here, maybe a little bit of an alleviation of input costs which we've seen some of we have, I mean, beef prices, chicken prices have started to come down when you think of mcdonald's burgers and chicken, you know, that, that could be helpful to them.
But I think that's gonna be offset by some of the factors that we talked about.
Got you.
All right.
So let's uh uh just quickly tell folks what positions you have if any in these two.
Sure.
So uh in the street pro portfolio that I manage, we are long Costco shares, we've got an 880 price target.
But we think once we get that price target.
Uh, sorry, once the membership fee increase comes through, we're likely to raise that.
And mcdonald's, uh, I would say simply Julie not loving it.
Um, and we actually sold the position in mcdonald's that we had very early in the year because of some of these concerns, particularly about the minimum wage increase in California.
Ok.
Interesting.
Chris Versace of Tamaica.
Good to see you.
Thank you for coming in and thank you so much for watching.
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