Best Stock for 2009: Costco

Which stocks are looking fine in ’09? Discover all our Foolish ideas for The Best Stocks for 2009.

As we enter what could be another turbulent economic year, picking a winning investment idea for 2009 isn't easy. The damage that began with our deflating housing bubble, and mushroomed into a financial meltdown, has raced through our economy at lightning speed, attacking nearly every sector.

Retail may be one of our hardest-hit industries. Tightened lending practices and the inability to refinance have left consumers with no outlet to fund their previously outrageous purchasing habits. And general fear for our economy's future has slashed spending budgets. It's safe to say that 2008 marked the end of the era of excessive luxury that plagued our nation the last several years.

In the same breath, it also marked the beginning of a new consumer trend: frugality. Our economy badly needs to deleverage, and while that process will be toxic to many retailers, it should also allow the strongest players to emerge in each of their respective niches. As Costco (Nasdaq: COST  ) CEO James Sinegal has said, "We have always believed that great companies build market share in really tough times."

The customer is truly No. 1
That's exactly what Costco has done during the past year, and precisely what I think it will continue to do in 2009. Throughout 2008, big-box retailers like Wal-Mart (NYSE: WMT  ) and Target (NYSE: TGT  ) and grocers like Safeway (Nasdaq: SWY  ) and Kroger (NYSE: KR  ) raised their prices in response to bubbling commodity costs. Rather than jumping on the price-raising bandwagon, though, Costco took slight margin hits and found unique ways to avoid passing on the higher costs to customers. From convincing vendors to redesign product packages to fit more items on a pallet, to commissioning its own pumpkin patch to maintain pumpkin-pie prices, the company has maintained a commitment to delivering the utmost value to its customers.

When Costco missed analyst estimates back in July, CFO Richard Galanti was quoted as saying "Some [of the shortfall] relates to us consciously holding some key price points on selected items to ... help our customers. We must and will maintain their confidence of what we stand for."

This is precisely the way companies build the brand loyalty they need from their customers. Galanti's statement also shows that management has long-term vision. Costco has proven that it has its customers' best interests in mind; that can go a long way to maintain and grow market share for years to come. That's especially important in times like these, where shoppers want to feel confident that they are getting the most bang for their ever-more-precious buck.

Strong financials
I my search for companies that will thrive in 2009, I sought specific characteristics that I think will separate the winners and the losers. As we've highlighted before, this is a make-or-break holiday season for many retailers, so companies with the following qualities seem more to me like buys for the coming year:

  • Strong inventory management
  • Manageable debt levels
  • Adaptability

Costco nails all of these points. While the company carries some debt on its balance sheet -- roughly 25.5% of equity -- its interest coverage ratio is 19.4, meaning it can easily pay its debt expenses with cash flow. On the inventory front, Costco excels. By offering a limited selection of items in comparison to grocers, the company consistently turns over inventory 12-13 times per year, meaning it typically receives payment for its inventory before it pays its suppliers. This, in turn, allows the company to alter its offerings quickly.

The "treasure hunt" strategy is the luring factor that brings customers to Costco, aside from its low prices. While the company's inventory management system is efficient enough to pare back on the higher-ticket items as consumers alter their spending habits, the company actually benefits from downturns. High-end vendors desperate to boost their anemic sales are arranging for their goods to be sold at Costco, which will stimulate consumers to shop there. Even Starbucks (Nasdaq: SBUX  ) is getting in on the action; it recently made a deal to offer gift cards at reduced prices, after years of turning Costco down.

Wholesale valuation
Retailers across the board are selling at steep discounts these days. Costco is certainly cheap in comparison to its P/E multiples over the past several years, but at around 18 times this year's expected earnings, it's nowhere near the bargain-basement levels of many teen retailers like Abercrombie & Fitch or electronics merchant Best Buy (NYSE: BBY  ) . However, in this environment, I strongly believe it's worth paying a premium for a company with a concept that still appeals to customers in tough times, a brand that won't fade away because of consumer fickleness, and financials strong enough to survive a prolonged recession and near-term revenue shortage. Costco fits the bill perfectly.

In a year when our economy must overcome the consequences of greed and fiscal irresponsibility, I can't think of a more transparent and honest company to believe in than Costco. Sinegal takes a salary that amounts to a fraction of many of his peers' paychecks, requests annual reviews of his performance, and passes on significant portions of his extreme cost-cutting measures to customers, rather than lining his own pockets. With leadership like this, Costco will be a top stock for 2009 and beyond.

Do you agree? Cast your vote by marking Costco an outperform or underperform on Motley Fool CAPS, and join more than 120,000 other Fools interested in making next year a profitable one.

Kristin Graham owns shares of Starbucks. Costco, Best Buy, and Starbucks are Stock Advisor recommendations, and Costco, Starbucks, Wal-Mart, and Best Buy are Inside Value selections. The Fool owns shares of Best Buy and Starbucks. The Fool's disclosure policy buys everything in bulk.


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