Costco Wholesale (NASDAQ:COST) stock looks stuck in a rut -- and may have itself to blame.
Same-store sales at the country's biggest warehouse retailer flatlined in June, then fell 2% in July. So it's little wonder that since the June news came out, all the way up to present day, Costco stock has hardly budged an inch, and still sells for about $166 and change.
That fact, and the uninspiring sales Costco has been putting up of late, aren't dissuading analysts at Cowen & Company from recommending the stock, however. In fact, Cowen, which already rates Costco stock an outperform, announced that it is raising its price target on the stock to $170 a share.
Here are three things you need to know about that.
1. Sales are by their nature deflationary
So why are Costco's same-store sales slumping? In a word: Groceries.
According to Cowen, "July comps of -2% were in line with the Street's -1.8% est." But as noted in a write-up on StreetInsider.com yesterday, Cowen says that "food deflation ... is limiting upside to comps." When food costs less, customers spend fewer dollars on it, even if they buy the same amount of groceries. Cowen believes this is the primary culprit behind Costco's sinking sales.
And if it's right, that may actually be a good thing. After all, if Costco can afford to sell groceries cheaper, it follows that Costco is probably buying those same groceries cheaper itself -- preserving its profit margins. Moreover, by passing along savings to its customers, Costco may be making a wise investment in customer loyalty. Those same customers saving money on groceries today, are likely to come back for more savings next week, and the week after that, and the week after that ...
2. It's not just Cowen that likes Costco
Simultaneously with Cowen releasing its price target hike, Barron's reported yesterday that analysts at UBS are similarly bullish on Costco. Like Cowen, UBS notes that "continued deflationary pressures in grocery" have depressed sales at Costco. Additionally, the company has willingly accepted "considerable top line pressure from eliminating tobacco SKUs at many locations." (According to UBS, kicking the cigarette habit alone cost Costco 0.75% worth of its same-store sales.)
Meanwhile, UBS argues that "the early disruption from" Costco switching credit card providers, ditching AmEx in favor of Visa, is now history. Members "are seeking to take full advantage of the new card's more attractive rewards structure," argues UBS, and over time, that's going to increase member loyalty to Costco -- and "accelerate" sales.
It just isn't happening yet.
3. What is happening?
Instead, what is happening at Costco is...not much. Recent declines in same-store sales notwithstanding, data from S&P Global Market Intelligence show that Costco's fiscal year-to-date revenue is actually up a modest 2.1% (because in addition to sales at existing stores, Costco is continuing to open new stores, which also add to sales). Profits are down, admittedly -- but only about 2.5% -- for the same period. So whatever is going on with same-store sales, it's not hurting Costco's business significantly.
What's more, Cowen notes that in the same July period where same-store sales declined, Costco's foot traffic rose 3.25%. Had grocery prices simply held steady during the period, therefore, it's likely we would have seen a rise in same-store sales in July, and not the small decline that actually occurred. Similarly, should groceries begin rising in price again, there's every reason to expect that Costco's sales will follow suit.
The most important thing: Valuation
Cowen and UBS make a strong case for the news at Costco not being as bad as it appears on the surface, and to that extent, I agree with them. But even admitting this, I'm not so sure I agree with the analysts when they take the next step, and actually declare Costco stock a buy.
Why not? Well, there's Cowen's new and improved target price for one thing. I mean, a $170 target? On a stock that already costs $166?
Even if Cowen is right about Costco heading to $170, the prospect of Costco stock rising 2% a year from now is hardly exciting. And one of the reasons Cowen may be right about Costco rising only to $170, is that it already costs quite a lot. At today's share price of $166 and change, Costco shares sell for a very rich multiple of 31.5 times earnings. And given that most analysts who follow the stock see Costco growing earnings at less than 10% annually over the next five years, there's really not a lot of room left for the shares to grow.
Long story short: Cowen and UBS appear to be right on the details about Costco stock -- i.e., the recent decline in same-store sales in not something to worry about. But they draw the wrong conclusion from those details. Investors shouldn't sell Costco because its sales are slumping. They should sell Costco because the stock just costs too darn much.
Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he currently ranks No. 309 out of more than 75,000 rated members.
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