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Is Costco Wholesale Corporation a Buy?

By Demitri Kalogeropoulos – Apr 16, 2018 at 7:02AM

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Find out why this high-performing retailer deserves a premium price.

The holiday season retailing results are all in, and one company stands head and shoulders above the rest. Costco (COST -1.91%) is growing faster than its peers while enjoying healthier profit gains. But are shares too pricey for investors to considering jumping into the stock today? Let's take a closer look.

Recent results

Costco's latest numbers were about as good as investors could hope to see in the retailing industry. Comparable-store sales are up 7% in the past six months while national rivals including Wal-Mart and Target expanded at closer to 3%.

A customer browses the aisles at a warehouse club.

Image source: Getty Images.

Its profit margin even ticked higher in the most recent quarter, which means Costco isn't being forced to slash prices to protect its market share. Both Target and Kroger, on the other hand, have posted lower operating margins while warning investors to expect reduced profitability for the foreseeable future.

Notably, Costco's market-thumping growth is coming while membership prices are climbing. Fee income, its main source of earnings, is up 11% over the past six months as more of its subscriber base rolls into the higher-priced plans the retailer launched last year.

These positive trends appear to have continued into the company's fiscal third quarter. Comps rose 6% in the month of March, the company revealed this week. Meanwhile, rising renewal rates, a growing store base, and higher membership prices should combine to power accelerating fee growth in each quarter of fiscal 2018, and into 2019, management estimates.

Chart showing fee income.

Annual fee income. Chart by author. Data source: Costco filings.

Online competition

E-commerce competition was a big worry for investors as recently as last October. That concern hasn't disappeared, either. Kroger is pouring resources into its home delivery offerings. Wal-Mart and Target are doing the same thing, and while all three rivals lack Costco's dominant market position, they do have more extensive sales bases from which to launch same-day delivery services. Then there's always Amazon which seems bent on pushing deeper into the grocery business including by expanding its physical footprint through moves like the recent acquisition of Whole Foods.

Costco's digital sales channel amounts to 4% of the business today and management has big plans to grow the segment over time. But the fact that this figure is lower than Target's 6% and Home Depot's 7% suggests that the warehouse giant's smaller footprint could be a liability as consumers increasingly opt for home delivery or choose to pick up online orders at their local store.

Premium valuation

Yet healthy metrics like customer traffic and membership renewal demonstrate that Costco's operating approach insulates it from the worst of the e-commerce challenge. That strength helps explain why it is the only major retailer to have outperformed the market over the past five years.

COST Chart

Data source: COST data by YCharts.

The key risk when buying a high-performing business like that is in paying too high a price. And Costco is indeed subject to a premium when compared to its peers. You'd have to shell out 0.6 times sales or 28 times trailing earnings for the stock. Walmart and Target, which also happen to pay heftier dividends, are cheaper by both metrics.

That's a premium worth paying, in my view, though, given that Costco trounces peers in the important operating metrics while delivering far more stable earnings growth. Yes, the warehouse giant's business could be pinched if consumers decide they don't want to physically shop for groceries and home products anymore. But Costco is thriving in today's multi-channel retailing environment, which makes it a great choice for investors seeking market-thumping sales and steady profit growth.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Demitrios Kalogeropoulos owns shares of Costco Wholesale and Home Depot. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has the following options: short May 2018 $175 calls on Home Depot and long January 2020 $110 calls on Home Depot. The Motley Fool recommends Costco Wholesale and Home Depot. The Motley Fool has a disclosure policy.

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Costco Wholesale Corporation
$478.98 (-1.91%) $-9.31

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