Is Costco Still Worth Buying?

Does weak quarterly performance suggest that Costco's days are numbered ?

Feb 11, 2014 at 7:00AM

Membership-warehouse club Costco Wholesale (NASDAQ:COST) reported a rather dull performance in its latest quarter. From an investment point of view, does this imply that the company isn't as valuable as it used to be?

Let's have a look at Costco in detail and also analyze two other players in the retail industry, Wal-Mart Stores (NYSE:WMT) and PriceSmart (NASDAQ:PSMT).

First-quarter earnings
Costco recently posted profits that missed consensus estimates. Wall Street expected earnings per share of $1.03, while the actual EPS came out to be $0.96. The company also missed its revenue estimates by almost $280 million.

In comparison to the last year, net sales grew by 3%. Net sales excluding membership fees rose 5% to approximately $24.5 billion, while revenue from membership fees jumped 7.4% to $549 million.

As Canada is Costco's second-biggest market, a weak Canadian dollar in relation to the US dollar resulted in lower revenue for the company. Volatility in fuel prices has also negatively affected the discount retailer in the last few months. Lower fuel prices enhanced sales volumes but pressured overall revenue.

What is Costco up to?
The 2% increase in quarterly earnings isn't huge, but Costco's long-standing strategy of offering low prices is definitely working. The company believes that this strategy will continue to increase its membership club, which will add more revenue in the future. Therefore, it's sacrificing its short-term earnings for future growth. The additional $38 million in membership fees during the quarter was a direct result of huge discounts being offered at the retailer, which made its membership more enticing.

 In the last few years, Costco has invested heavily in upgrading its e-commerce business and in-store IT modernization. According to the company's CFO, Richard Galanti, this heavy investment was one of the reasons why the company's earnings fell by three basis points. The spending is likely to continue this year as well, due to which the company's earnings will get affected to some extent. However, this will enhance Costco's store efficiency, which will drive more market share in the long run.

Costco is expected to open 16 more stores in the US during fiscal-year 2014. Overall, the company has plans to open a total of 30 stores this year, including two stores in its new market -- Spain. As the US market is getting saturated with intense competition, retail margins aren't expected to jump in the near future. For this reason, Costco is also focusing on markets such as Australia, Japan, Korea, Mexico, and Spain.

Fundamentals
Costco has a low price-to-earnings ratio of 24.6 in comparison with the industry average of 24.7. The lower price-to-sales of approximately 0.5 and price-to-book value of about 4.5 strengthen my belief that the company is a good bargain at this moment. Costco also has a lower beta coefficient of about 0.6 as opposed to the industry average of 0.8, indicating that it's a rather stable company. 

Competitors
In the third-quarter, Wal-Mart's profit rose 3% to $1.14 a share, topping analysts' estimates by $0.01. Sales for the quarter increased 1.6% to $115.7 billion, which fell short of Wall Street expectations by 1%. Comparable sales in the US also fell by 0.3%.

The Chinese e-commerce business is expected to yield a composite annual growth rate of 32% from 2012 to 2015; therefore, Wal-Mart is investing heavily in the Chinese market. The company has a goal of opening more than 110 facilities in China by the end of 2016. In the US, Wal-Mart has plans of increasing its small- format stores to 400 by year-end, as these stores are doing better than the company's large supercenters.

PriceSmart recently announced its earnings for the fiscal first quarter. The company's share price dipped slightly as the earnings missed expectations by $0.03. Adjusted earnings grew to $0.71 from $0.66 in the year-ago quarter. Same-store sales increased by 7.9%, which is great for any retailer, but it still disappointed analysts who compared performance to the comparable-sales jump of 9.3% and 9.2% in the third and fourth quarters, respectively. 

The company operates 32 warehouses, as compared to 29 stores during the same period last year, and is looking to further expand into lucrative markets of Colombia, Costa Rica, and Honduras. 

Final thoughts
Despite falling short of analysts' expectations, Costco's future looks bright. External factors such as a weak economy, fuel prices, and exchange rates have negatively affected the company's earnings in the recent past. However, the company's core business is still going strong. Costco's strategy of offering low prices to make its membership more attractive gives it an edge over its rivals.

Moreover, a well diversified product mix adds more value to the company. Investments in in-store IT and e-commerce will increase costs this year but will certainly pay off in the long run. Considering all of this, Costco looks to be a good investment choice at this point in time.

To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.

 

Zahid Waheed has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale and PriceSmart. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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