Costco: Does Double Digit Growth Justify the Company’s Premium Valuation?
There aren’t many companies in the world that generate more consistent profit/profit growth than Costco (COST). Over the past 20 years, this company has generated negative year-over-year earnings-per-share growth just twice (a -4% performance in 2001 and a -14% performance in 2009). While Costco suffered a bit during the dot-com boom/bust at the turn of the millennium and during the Great Recession in 2008-2009, the company’s performance was very strong during the COVID-19 recession in 2020. Shares posted 13% earnings growth during fiscal 2020 and analysts expect to see COST’s bottom-line grow by another 15% during fiscal 2021. And, after another strong earnings report last month and a stellar same-store-sales report for the month of May, COST shares are trading near all-time highs. Costco is up nearly 25% from its March 2021 lows and after such a strong rally, we wanted to take a look at what the Nobas blue chip (4 and 5 star rated) analysts had to say.
On May 13th, Seeking Alpha editor Clark Shultz, a Nobias 4-star rated analyst, published a note which highlighted a pre-earnings upgrade that Christopher Graja, an Argus analyst, provided on COST shares. Argus issued a bullish report prior to COST’s fiscal 2021 Q3 report, raising its full-year 2021 earnings-per-share target from $10.29 to $10.40 and its full-year 2022 earnings-per-share target from $10.80 to $10.90. In the report Graja said, "We believe that Costco's financial strength and ability to deliver exceptional value to consumers are key differentiators for the stock in the current market environment. Our analysis of core operations suggests that execution of the business plan remains excellent with historically strong traffic and membership renewals. If investors are looking for clues to our future ratings or target changes, these two measures of member engagement are likely to be important indicators because they are drivers of earnings growth and earnings stability."
And, it turns out, Graja’s bullish sentiment was well placed. When Costco reported Q3 results on May 27th the company beat analyst estimates on both the top and bottom lines. Costco’s Q3 sales came in at $45.28 billion, up 21.5% year-over-year. The company’s GAAP and non-GAAP earnings-per-share came in at $2.75 and $2.84, respectively. The GAAP EPS figure beat analyst estimates by $0.41/share and the non-GAAP figure was even more impressive, topping expectations by $0.56/share. During Q3, Costco’s same store sales grew by 15.1% year-over-year. And, the company’s eCommerce sales increased by 38.2%.
Demitri Kalogeropoulos, a Nobias 5-star rated analyst, recently published an article at the Motley Fool, which showcased the company’s strong Q3 results. Kalogeropoulos began his piece touching upon COST’s 15%+ comparable sales growth figure, saying, “That increase reflected one of the strongest consumer spending environments in years.” However, he believes that the same-store-sales figures only tell a small portion of COST’s growth story and highlighted 3 other metrics that he believes investors should also be focused on. He liked the company’s membership renewable rate figures, saying, “Nearly everyone who had an invitation to let their membership lapse chose instead to pay up for another year. Costco's subscription renewal rate was 91% this quarter, keeping it at the near-record level that it has been at for over a year.”
There’s a lot of competition in the retail space, especially with regard to eCommerce, but it appears that the vast majority of Costco customers believe that their membership fees are well worth the cost. And, this customer satisfaction falls straight down to Costco’s bottom line. Kalogeropoulos said, “The strong renewal rate also lifts earnings, with membership income rising to $900 million from $815 million a year ago. That accounts for over half of Costco's operating earnings.”
Another important metric that he tracked during the recent quarter was inflation. Rising inflation has the potential to hurt earnings/cash flows of retailers if they’re not able to pass along those costs to consumers. And, in an ever competitive retail environment, Costco appears to be a winner in this regard. Even as inflation rises above the company’s prior estimates, Kalogeropoulos said, “Costco is using its clout in the industry to minimize the effect on shoppers through strategies like front-loading orders. Yet prices are still creeping up as costs rise on everything from aluminum to plastic, pulp, freight, and commodities. That inflationary environment favors Costco, given its price leadership status in the industry.”
Kalogeropoulos concluded his piece by putting a spotlight on the company’s consumer traffic trends. While it’s trendy for retailers to focus primarily on eCommerce growth (because that’s what investors like to see), the fact is, Costco continues to offer compelling reasons to drive consumers into its stores. Kalogeropoulos mentioned that even with online sales growing by more than 38%, consumers “Still flooded Costco's retailing warehouses, with traffic rising by double digits again this quarter. The big boost came from its non-food aisles that tend to carry higher profit margins. The fresh food niche contracted slightly but was still high by historical standards.”
One of Kalogeropoulos’s colleagues at The Motley Fool, Nobias 4-star rated analyst, Eric Volkman, also recently published an article offering a bullish outlook on COST shares. The article was focused on the Motley Fool analysts top investment ideas during an inflationary environment and Volkman chose Costco saying, “In inflationary times, consumers usually turn to retailers that consistently and reliably offer low prices. That's why my pick would be the stock of a retailer that competes very effectively on that basis and manages to make a healthy profit while doing so: Costco Wholesale.” He continued, highlighting unique competitive advantages, saying, ‘What sets Costco apart from your neighborhood grocery or supermarket chain is that it functions effectively as a giant shopping club. Like any club, membership is required for admission, and the company makes a tidy sum on fees for this.”
Like Kalogeropoulos , Volkman also touched upon the $881 million worth of membership fees that COST generated during Q3. With regard to retail profits and profit margin, Volkman explained that the company’s strong infrastructure is what allows Costco to still make money while offering such good deals. He mentioned that there are “809 Costco warehouses spread throughout the world (as of the end of April), the vast majority of which (559) are based in the U.S.”
Volkman said that Costco’s “annual free cash flow has ballooned, from $2.8 billion in 2018 to over $6 billion a mere two years later. This is more than enough to fund a dividend that's been raised once annually for years, although the yield is low (0.8%) due to the strong popularity of Costco stock.” And, he added that this low dividend yield is a bit misleading because of the regular special dividends that the company had paid over the years. Obviously no dividend is ever guaranteed, but he says, “The company also pays one-off special dividends in particularly abundant years. The most recent one was dispensed in December and totaled a hefty $10 per share.” This extra $10 in passive income per share certainly helped to bolster the company’s total returns in 2020.
The most recent report that we saw regarding COST shares came from Shultz at Seeking Alpha again. On June 3rd, he reported that Costco’s comparable same-store sales figures for the month of May rose 22.8% compared to last year. He said, “Comparable sales in the U.S. were up 21.9% and e-commerce sales increased 12.1%.”
Nicholas Ward is a Senior Investment Analyst at Wide Moat Research. He has spent the last 8 years writing about the stock market at various publications, including Seeking Alpha, The Street, Forbes Real Estate Investor, Sure Dividend, The Dividend Kings, iREIT, Safe High Yield, and The Intelligent Dividend Investor.
Shultz also noted, “Excluding the impact of gas and F/X, comparable sales were up 14.7% including a 16.7% jump in the U.S.” Overall, this 22.8% result missed consensus analyst expectations of 23.4%. However, this slight miss wasn’t enough to significantly impact shares and the longer-term trajectory remains positive.
While it’s clear that COST is one of the leading growth companies in the retail space, quality is just one portion of an investment thesis. Valuation is the other and this is where investors sometimes become cautious when it comes to COST shares. Because of its very reliable growth, COST tends to trade at an outsized premium relative to its peers, as well as the broader market.
Today at $387.52/share, COST is trading for more than 37.4x its expected 2021 earnings. Not only is this premium nearly double the forward looking multiple attached to the S&P 500, but it is also well above Costco’s own 10 and 20-year average P/E ratios of 28.75x and 25.4x, respectively.
The company’s growth is likely to continue to grow in the coming years, yet it could take quite some time for the expected high single digit/low double digit growth that the analyst community expects to see from COST to justify today’s share price. However, when looking at the recent reports published by the Nobias 4 and 5-star rated analysts on COST shares, the blue chip analyst community that we track appears to be willing to overlook valuation concerns and instead, focus on COST’s growth and shareholder returns, because of the 14 reports that we’ve seen published since the start of March, only 4 offered “Sell” ratings.
Disclosure: Nicholas Ward has no position in COST. Nicholas Ward wrote this article for Nobias at their request with a view of giving investors a balanced perspective based on the writings of Nobias highly rated analysts and bloggers. Nobias has no business relationship with any company whose stock is mentioned in this article and does not have a position in this stock.
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