Is This the Time to Buy Costco?

Costco's latest comparable sales have given investors a renewed hope.

Apr 15, 2014 at 3:40PM

Costco Wholesale (NASDAQ:COST) recently reported a 5% increase in its same-store sales for the month of March; analysts at Thomson Reuters were expecting a 3.5% rise in comps. Does this mean the company has become a buy? Let's analyze Costco and see where it's heading in comparison to its peers Wal-Mart Stores (NYSE:WMT) and Target (NYSE:TGT).

What's cooking at Costco?
Costco experienced a drop of more than 15% in its second-quarter earnings. The retailer reported earnings of $1.05 per share compared with $1.24 a share in the year-ago quarter. There were a number of reasons for this slowdown. First, higher discounts in the holiday season contributed to lower margins for the retailer. Second, the swings in foreign exchange rates translated into lower profits from the company's international business. Third, the company's weak performance in the fresh food business also brought in fewer sales.

Although revenue grew 6% to $26.3 billion, it missed analysts' expectations of $26.65 billion. Excluding the impact of currency exchange fluctuation and volatility in gasoline prices, same-stores sales grew 5% internationally, while they jumped 4% in the U.S. market. Costco generated robust sales throughout the quarter from Southeastern and Midwestern states in the U.S. The strongest sales from the company's international operations came from Mexico and Canada. Average shopping frequency at the company's stores increased by 4%.

Membership fees contributed $550 million in total revenue, representing year-over-year growth of 4.1%. New membership signups grew 13%, thanks to strong sign-ups at newly opened stores in Japan and Australia. More than 200,000 new executive members were added during the quarter. Costco's executive members are important to the company, as they contribute about 35% to the company's total sales.

Costco has also extended its partnership with C2FO, which will enable Costco's suppliers to continue taking advantage of C2FO's early payment scheme. C2FO provides working capital funding to suppliers at competitive rates to improve their cash flow and cash management. C2FO has an overall supplier recommendation rate of 91% and Net Promoter Score of 60 (an NPS of more than 50 is thought to be world-class). The deal means more suppliers will now be working with Costco, which will eventually help in reducing the company's cost of goods sold.

At the moment, Costco has e-commerce operations in the U.S., Canada, Mexico, and the U.K.. The company's latest e-commerce site is costco.com.mx, which was launched for its Mexican customers. During the past few quarters, the company has upgraded its site by adding more categories to e-commerce, which includes apparel and new health and beauty aids. The retailer has added some mobile apps as well.

Fundamentals

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Of all these retailers, Costco has the highest 52-week return. In fact, it's the only retailer that has given a positive return in the last 52 weeks. It's also the most expensive, as evident by the company's high price-to-earnings and price-to-book value ratios. 

Competitors
Retail giant Wal-Mart struggled to combat sluggish sales in its most recent quarter. Earnings for the company came in at $1.60 per share, down from the $1.67 a share it earned in the same period a year earlier. Revenue increased a mere 1.4% to $129.7 billion. Besides other factors, the company suffered a decline in sales on account of steep cuts in food stamp benefits by the government. Since Wal-Mart's small-format stores continue to gain wide popularity among its consumers, the company expects to open 270 to 300 such stores by the end of this fiscal year. 

The third largest U.S. retailer, Target, is still facing law suits over the infamous data breach. The company said in December last year that over 70 million of its clients' personal and credit card details were compromised. Since then, the retailer has been struggling to revamp its business by winning back consumers' confidence. Target has already incurred over $61 million in expenses related to the investigation. Earnings during its holiday quarter plunged 46% to $0.81 per share, while sales declined by 5.3% to $21.5 billion.

Final thoughts
Costco's latest comparable sales data show that the company's on track. However, the company had average second-quarter results. Had foreign currencies remained stable, the company's performance would have been more satisfying. One of the highlights during the quarter was new sign-ups, which kept growing at a fast pace. Costco continued to add more executive members, which have always been the key to the company's growth. Further, Costco's partnership with C2FO will allow the retailer to improve its margins in the coming quarters. On the whole, Costco appears to be a good investment choice at this point in time.

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Zahid Waheed has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. 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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