A Discount Retailer with a Lot of Growth Potential

Since Costco's (NASDAQ: COST  ) primary goal is to drive profitability through comps growth, it makes a lot of sense to look at the company's comps performance. We could then compare Costco to Wal-Mart (NYSE: WMT  ) and Target (NYSE: TGT  ) to determine which of the three is likely to offer the best investment opportunity going forward.

Recent results
In September, Costco's net sales improved 6% year over year primarily driven by comps growth of 3%. Comparative sales grew at a 4% clip in the United States, but they were flat internationally. That international number might come as a surprise. However, if you exclude factors that are beyond the company's control, such as foreign exchange rates, total comps grew 5%, with domestic comps and international comps growing 5% and 6%, respectively.

In the fourth quarter, net sales increased 1% with comps increasing 5%. Domestic comps grew 5%, and international comps increased 4%. Diluted EPS came in at $1.40 versus $1.39 in the year-ago quarter, with earnings-per-share positively affected by $0.14 due to a tax benefit related to a special dividend paid last December.

All of that is important. None of it is as important as the bigger picture, which is the fiscal year. For fiscal-year 2013, net sales improved 6%, with comps increasing 6%. Domestic and international comps both improved 6%. Increased foot traffic and a 10% increase in membership fees helped drive comparative sales, as well as net sales. Diluted EPS increased 19% to $4.63 (with the aforementioned tax benefit contributing $0.14).

Costco opened 26 new warehouses in FY 2013 versus 16 new warehouses opened in FY 2012. This indicates that Costco is optimistic about its future prospects.  

Since Costco is a low-margin operation, gross margin and SG&A expenses play big roles. For the fiscal year, gross margin improved seven basis points, and SG&A expenses increased 1 basis point. Neither of these are big moves, which is a net positive.

Costco's strategy
In order to drive comps growth, Costco aims to consistently offer trend-worthy merchandise at the right prices. This is the only way to fend off competitive threats. This can be a delicate balancing act, but Costco has proven to be very good at it through the years. Costco has also been highly adept at choosing quality locations. While square footage growth is limited domestically, Costco has plenty of square footage growth opportunities internationally. 

Currently, Costco also offers a great deal of geographic diversification, with the following warehouse breakdown:

  • United States: 454
  • Canada: 85
  • Mexico: 34
  • United Kingdom: 25
  • Japan: 18
  • Taiwan: 10
  • Korea: 9
  • Australia: 3

Costco vs. peers
Costco has outperformed Wal-Mart and Target on the top line over the past year:

TGT Revenue (TTM) Chart

TGT Revenue (TTM) data by YCharts

It has also shown more bottom-line growth than Wal-Mart and Target over the past year:

TGT EPS Diluted (TTM) Chart

TGT EPS Diluted (TTM) data by YCharts

In a CNBC interview, Wal-Mart CEO Bill Simon mentioned that the company had seen slowing sales in government employment areas. However, this is a temporary event, and Simon noted that on an overall basis he has been impressed by the resiliency of consumers, who will always adjust and find a way to provide for their families.

Additionally, Simon mentioned that mobile devices are extremely hot. This has been aided by the company's trade-up program. Simon also said that Wal-Mart has bought deep for the holidays (the amount of products available will be high), and that he expects this to be the best Black Friday ever.

Target is growing in a different way with plans to open 33 new stores across nine provinces in Canada. Thirty-one of those stores will open on Nov. 13, with the other two opening on Nov. 22. Target thinks these stores will drive demand for several reasons. One is broad product diversification, offering everything from toys to apparel to food. In some cases, merchandise will be based on local demand. Cleanliness, wide aisles, affordability, and the presence of Starbucks and pharmacies in most locations are also expected to drive foot traffic. 

Target and Wal-Mart are more mature companies than Costco, always looking for creative ways to drive top-line growth. There are more growth opportunities for Target than there are for Wal-Mart since Target doesn't have nearly as much international exposure. However, Wal-Mart always finds ways to grow, primarily by stealing market share from other companies by invading their geographic markets.

Wal-Mart operates 11,000 stores, whereas Target operates 1,870 stores and Costco operates 638 warehouses. For this reason alone, Costco has the most growth potential. Costco also yields 1.10%; however, that's not as high as Target at 2.70% or Wal-Mart at 2.50%.

The bottom line
If you're looking for steady growth and generous dividend payments, consider Target or Wal-Mart. If you would prefer to invest in a company with more growth potential that's seeing consistent comps growth and offers a decent yield, take a look at Costco. This is an extremely well-run operation that can be invested in with confidence. Any drops in the stock price can be looked at as buying opportunities. 

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