In the latest installment of Yahoo Finance's Good Buy or Goodbye, Julie Hyman is joined by Wall Street Alliance Group Partner Aadil Zaman to discuss his stock picks to buy and avoid in the home improvement sector.
As a potential buy, Zaman spotlights Costco (COST), arguing that "Costco's customers aren't going anywhere" given its loyal membership base and "recession resilient" low-cost model. Despite e-commerce trends, he says Costco proves "a brick-and-mortar retailer can not only survive, but also thrive."
With renewals in the 90th percentile, Zaman sees limited consumer defections, though notes risks if Costco raises membership fees for the first time since 2017. Additionally, its dividend strategy allows flexibility to "time the dividend for when it makes the most sense."
Conversely, Zaman names RH (RH) as a stock to avoid, calling it the "Costco opposite" with its luxury furnishings reliant on home sales - now falling with high rates keeping homeowners "staying put." With consumers cautious, he says few look to splurge on luxury furniture. He also points out that Berkshire Hathaway exited its entire RH stake, which could be a signal of wider concerns.
You can find more of Good Buy or Goodbye here, or watch this full episode of Yahoo Finance Live here.
Editor's note: This article was written by Angel Smith
Video Transcript
[MUSIC PLAYING]
JULIE HYMAN: It's a big noisy universe of stocks out there. Welcome to Good Buy or Goodbye. Our goal to help cut through that noise to navigate the best moves for your portfolio. Today we're looking at two companies in the home improvement sector, but with two very different business models and price tags.
We're looking at luxury versus the bargain hunting consumer. What's the best way to play it now, I'm here with Aadil Zaman partner at the Wall Street Alliance Group. And let's get straight to it here.
Your buy stock is Costco, which, of course, is in the money saving sector. Although, it has traditionally actually attracted a higher end consumer, the stock has done pretty well over the past year. Let's talk about why you still like it.
First of all, the so-called economic moat. What makes Costco different than other retailers?
AADIL ZAMAN: Yeah. So Costco shows us that how a brick and mortar retailer in this environment where people like to do their shopping online. How a brick and mortar retailer can not only survive, but also thrive. So their economic moat is very simple.
They keep it simple. They're not making too much money on the products. Their margins are razor thin.
So they keep the prices very low. They attract the consumers into the stores. And then they make money on the back-end on the membership fee, right?
So more than 70% of their profits are coming from membership fee. And as human beings, we always crave for the in-person experience as well, even though we like the convenience of online. And Costco provides a great option for consumers to get that valuable in-person experience for their shopping needs.
JULIE HYMAN: Right. And once they have that membership, they don't want to give it up. And that speaks to the strong customer loyalty that Costco has.
AADIL ZAMAN: Yes. So Costco's customers aren't going anywhere. So they're renewing their subscriptions. Their subscription renewals are in the 90%-- near 90%.
So that what that does is it makes their business very interesting. It makes them relatively recession resilient, right? So every year, they are making their membership fee no matter what.
And if the economy goes down, they're still making the membership fee. If economy goes up, they're still making the membership fee. Compare that to a retailer that's heavily dependent on product sales would be very vulnerable during economic downturns.
JULIE HYMAN: Right.
AADIL ZAMAN: And they haven't done a membership fee increase since 2017. So what that leads us to believe is that we are expecting that they should do another membership fee increase in the near future. You saw a Netflix earnings that came out. They are benefiting from raising their prices.
I think Costco will have the same benefit. And its subscribers are not going anywhere. So they'll benefit from that.
JULIE HYMAN: The one thing I'm not happy about is New Jersey Transit raising its fares. But that's a different story. And then there's the dividend strategy here, right?
So Costco tends to do kind of special dividends. And is that something that you guys like?
AADIL ZAMAN: Yeah, we love that. Because with rates going down, a lot of these investors that are in money markets, they're going to come out and they're going to be hungry for yield. And so they're going to go to the dividend payers.
Costco is a great dividend payer. It's not a traditional dividend payer. So if you look at the dividend yield itself, it's actually quite low.
But what it does is that every now and then, it'll give a windfall big dividend like the recent $15 a share dividend that they gave. And that's great for shareholders because it's a big reward for them. It's also great for Costco because they can give that. Rather than giving a fixed amount every quarter, they can time the dividend based on when it makes the most business sense for them. So that's why we like this as a dividend pay as well.
JULIE HYMAN: All right, let's get to the risk here. And the risk is tied to what you talked about. Maybe that membership fee increase doesn't come. I mean, after all we've been waiting for it now for a little while and it hasn't materialized.
AADIL ZAMAN: Yeah, that's true. So a lot of the stock has gone up quite a bit. Part of the reason is that it's widely anticipated that they'll do a membership fee increase. So if they don't do that increase, it could potentially be some type of a short term sell off.
But looking at it from a long term picture, I think this will be fairly benign because they're doing so many other positive things which could neutralize this. So, for example, they are like taking a page from Netflix, they're cracking down on members sharing their cards with non members, right? So I think that will make the existing membership model even more profitable.
JULIE HYMAN: Gotcha. And just to be clear, do you own shares of Costco?
AADIL ZAMAN: Yes.
JULIE HYMAN: OK. OK, good to know. Now, you're goodbye is RH. Now RH, interesting company. The company formerly known as Restoration Hardware very leveraged to the higher end consumer here. And you say that consumer right now is kind of cautious.
AADIL ZAMAN: Yeah, so with RH, we would say avoid RH for the same reasons that we love Costco, right? So RH is like a Costco opposite where Costco is selling cheaper products, RH is selling expensive products. Where Costco is making money on the membership fee, RH is more product reliant.
And in environment where the consumer is being careful about how they spend their money, I think luxury furnishing is just not one of those items in our opinion. So that is why we would say that this-- I mean, I love going to the galleries.
In New York City, it's beautiful. It's really tough to get a reservation in the restaurant, which is amazing as well. But I think as far as luxury furnishing is concerned, consumers are not very excited at all.
JULIE HYMAN: Well, and you say they're also levered to home sales, which as we know existing home sales in particular have been trending down because of high rates.
AADIL ZAMAN: Yes. So people have locked in low rates. I have locked in a low rate for my apartment in the city. And we are staying put.
We don't want to get a new home and pay a higher mortgage, right? So until that's the case, if you're not moving and you're not buying a home, there's no reason to spend a lot of money on new furniture and especially luxury furniture. So I think for that reason, Costco for the near future continues to suffer.
JULIE HYMAN: Gotcha.
AADIL ZAMAN: Sorry.
[INTERPOSING VOICES]
JULIE HYMAN: And then finally last May, we learned that Berkshire Hathaway had exited its entire stake in RH. And you saw that as a bad sign.
AADIL ZAMAN: Yes. So Berkshire Hathaway through its various different businesses has a bird's eye view of how the home improvement space is doing. And we feel that since they exited that space, since they got rid of RH, I think that gives us a pretty good idea of what's happening there. And we would follow Mr. Buffett's lead over there and we would avoid RH
JULIE HYMAN: Gotcha. Now what could go right for RH I guess if you would see a recovery in the home sales market that would lead people to buy new furniture, right?
AADIL ZAMAN: Yes. So if rates go down, you know, and suddenly like there are a lot of homes being sold, and people are going out there, and they start buying luxury furniture, all of a sudden, I think that's something that could happen. Make our case incorrect.
JULIE HYMAN: Right.
AADIL ZAMAN: But in reality, I think given the strength that you're seeing now in the economy, you'll see the GDP numbers this week also. I think the rate cuts are going to be relatively slow. And I think for that reason, this scenario is quite unlikely.
JULIE HYMAN: OK, well, let's sum up what you have told people. Basically, buy Costco based on its strong customer base, the ability to sell cheap products and make the majority of its profits through that membership fee. On the other side, you say avoid RH given the current housing market stalling in a high rate environment and warning signs coming from the street as Warren Buffett exited that holding.
So thank you so much, Aadil Zaman. Appreciate it. And thank you for watching this installment of Good Buy or Goodbye.
