Tuesday, October 19, 2021

Costco: Deserved Rich Valuation, Little Room for Upside

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(C) Reuters. Costco: Deserved Rich Valuation, Little Room for Upside

Costco (NASDAQ:COST) primarily engages in the management of membership warehouses.

The company currently operates 817 warehouses, 565 of which are located in the United States and Puerto Rico, while Costco also operates e-commerce sites in the U.S., Canada, the United Kingdom, Mexico, Korea, Taiwan, Japan, and Australia.

From an investor’s perspective, what differentiates Costco from the rest of traditional retailers is its membership offering, which translates into a consistent stream of predictable cash flows.

For this reason, Costco has the ability to offer products at a great discount, which in turn maximizes customer retention, allowing for unparalleled economies of scale.

Costco’s success over the years has translated into incredible shareholder returns. Simultaneously, however, shares have traded at a premium.

While I appreciate the company’s unique qualities, Costco likely offers limited upside in the short term at its current valuation levels. For this reason, I am neutral on the stock. (See COST stock charts on TipRanks)

Neverending Growth

Costco recently posted its Q4 and full-year FY2021 results, marking another year of robust growth.

During the quarter, revenues increased 17.5% to $61.4 billion, from $52.3 billion last year. For the fiscal year, revenues grew 17.7% to $192.1 billion versus the previous year.

Consequently, net income for the year also grew to $5 billion (EPS of $11.27), compared to $4 billion (EPS of $9.02) in FY2020.

Out of total sales, $3.9 billion were attributed to membership fee income. The company now counts 61.7 million households, or 111.6 million cardholders, while it achieved a 91.3% renewal rate in the U.S. and Canada.

As the company continues to scale, its margins continue to expand. Despite razor-thin industry margins, Costco managed to retain its gross margins in the double digits. They expanded from 11.1% to 11.2% year-over-year.

Stock Is Not Cheap

Costco’s growth has shown no signs of slowing down over the past few years, with the company’s international expansion performing better than expected, especially in Asia.

As the company continues to achieve operational efficiencies and higher margins, profitability should keep snowballing in the coming years. Hence, investors have set, as always, high expectations for Costco.

Analysts now expect FY2022 EPS of around $12.05, which implies a forward P/E of 37.1. This is a considerable premium for the industry. Target (NYSE:TGT) and Walmart (NYSE:WMT), for context, trade with forward P/Es of 18 and 22.3, respectively.

On one hand, Costco’s execution over the years has been phenomenal, and EPS should eventually grow into the current multiple. Still, there is little to no upside in terms of a further valuation expansion.

Rather, any potential headwinds could easily result in a valuation multiple compression. Therefore, investors’ margin of safety has been compressed.

Wall Street’s Take

Turning to Wall Street, Costco has a Strong Buy consensus rating, based on 13 Buys, six Holds, and zero Sells assigned in the past three months. At $481, the average COST price target implies 7.5% upside potential.

Disclosure: At the time of publication, Nikolaos Sismanis did not have a position in any of the securities mentioned in this article.

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Costco: Deserved Rich Valuation, Little Room for Upside

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