Does Costco Stock Still Have More Upside?

COST: Costco logo

Despite an almost 24% rise since the beginning of this year, at the current price of around $365 per share, we believe Costco’s stock (NASDAQ: COST) still has more to go. The warehouse club operator has clearly benefited from accelerated shopping activity as more consumer dollars were directed toward goods rather than experiences. In fact, Costco’s sales have surged almost 12% in 2020, even though it didn’t invest in the curbside pickup or other omnichannel strategies that would have raised expenses. It should be noted that Costco’s comparable sales shot up 17% in the recent fiscal Q1, (excluding the impacts of currency fluctuations and gasoline price deflation), a double-digit sales for a second consecutive quarter this year. This, in turn, led to massive growth in Costco’s earnings, suggesting that the retailer’s stock still has plenty of upside in the long run.

Costco has a unique business model based on membership fees – where it collects fees from its members and sells items in bulk at rock-bottom prices while making most of its operating margin from these membership fees. This is despite the fact that these fees account for only 2% of the company’s total revenues. The company’s membership renewal rates continue to exceed 90% in the U.S. and Canada in 2020. The stay-at-home orders during the pandemic also appear to be encouraging more customers to upgrade to Costco’s executive membership, which costs twice as much but offers 2% cashback on most purchases. Costco’s stock is already about 58% higher than it was at the end of FY 2018 (year ended August 2018). Our dashboard, What Factors Drove 58% Change in Costco’s Stock Between FY 2018 and Now?, provides the key numbers behind our thinking, and we explain more below.

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Some of this growth over the last 2 years is justified by the roughly 18% increase in Costco’s revenues from $141.6 billion in fiscal 2018 (year ended august 2018) to $166.8 billion in fiscal 2020. In addition, earnings growth, on a per-share basis, was higher by 27%. This was driven by a 20 bps net margin expansion from 2.2% to 2.4%, partially offset by a slight decline in shares outstanding during this period.

Finally, Costco’s P/E ratio increased from about 32x at the end of FY 2018 to 38x at the end of FY 2020. While the company’s P/E is now around 40x, it could expand modestly as the demand for groceries could still remain high in the near term.

So how has Coronavirus impacted the stock?

In the recent Q1 2021 (ended November 22), the retailer’s total revenue increased 17% year-over-year (y-o-y) to $43.2 billion. In addition, its gross margin improved by approximately 0.5 percentage points, driven by the tailwinds of higher labor productivity and lower spoilage for fresh foods (due to higher sales of fresh foods). Consequently, operating income surged 35% y-o-y, due to lower selling, general, and administrative expenses. Also, Costco’s adjusted earnings per share grew 33% y-o-y to $2.30 (excluding various one-time tax benefits).

Costco has the lowest markup in the industry which creates an extremely compelling value for members. To add to this, the March acquisition of logistics company Innovel Solutions should also help Costco increase its sales of big-ticket items in the years ahead. Costco’s stock is certainly pricey right now. But considering the company’s large long-term growth opportunities, it still looks like a solid investment opportunity.

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