Costco Wholesale (COST 1.09%) is one of the true survivors of the so-called "retail apocalypse." It hasn't just scraped by, but has continued to grow at an admirable rate. As a result, Costco stock has roughly doubled over the past five years, easily outpacing the S&P 500.
Investors have gotten a lot of news to digest this month. The warehouse club giant reported its earnings for the fourth quarter of its 2018 fiscal year in the first week of October and released a sales update for September -- the first month of fiscal 2019 -- last week. Let's take a look at what these updates may mean for Costco stock going forward.
Q4 earnings: solid but not exceptional
Costco reported its sales results for the fourth quarter in early September, revealing a strong 7.2% increase in comp sales, excluding currency fluctuations and gasoline price inflation. Q4 net sales rose 5% despite there having been an extra week in the prior-year period.
On Oct. 4, Costco filled in the rest of the details on its quarterly performance. Membership fee income climbed 5.7% to $997 million, as the benefit of fee increases implemented in mid-2017 offset the impact of having one fewer week in the quarter.
Earnings per share reached $2.36, up 13.5% from the fourth quarter of fiscal 2017 and in line with the average analyst estimate. Costco CFO Richard Galanti noted that EPS would have increased about 20% excluding the extra week in the fourth quarter of fiscal 2017. That said, about 10 percentage points of this EPS growth was driven by a lower federal corporate tax rate. Higher interest income also contributed to Costco's earnings growth.
Costco reported in-line earnings for its fiscal fourth quarter earlier this month. Image source: Costco Wholesale.
Meanwhile, operating income ticked down slightly on a year-over-year basis, even though net sales increased by 5%. Thus, Costco's sales growth was offset by an operating margin decline. This was driven by a big wage increase implemented in June, along with a mix shift in terms of which merchandise categories posted the biggest sales gains.
Lastly, Costco revealed in the earnings release that it will report a "material weakness" in its internal controls related to financial reporting. (IT contractors who were given access to sensitive data for various projects didn't have that access removed as quickly as it should have been after they finished, according to Galanti.) While the company doesn't expect to restate any earnings results, Costco stock still stumbled based on news of this mishap.
September sales shine
On a brighter note, Costco recently reported another month of strong sales growth to kick off fiscal 2019. September comp sales rose 8.4% on a reported basis and 7.3% adjusted for currency fluctuations and rising gasoline prices, roughly in line with the company's fourth-quarter sales result.
Costco posted strong sales growth in all regions of the world last month, driven by a 4.6% uptick in customer traffic at existing warehouses. Within the U.S., the Midwest and San Diego markets remain particularly strong, while Spain, Mexico, and Japan are still leading the way abroad.
Looking at merchandise categories, softlines and hardlines were the standouts. With numerous major retailers having gone bust recently, Costco is likely to continue gaining share in apparel, appliances, home furnishings, and toys, among other categories.
With EPS growth slowing, Costco stock seems too pricey
Despite increasingly difficult comparisons, Costco continues to deliver strong sales growth. On the other hand, Costco stock has a lofty valuation of 29 times forward earnings. This seems overly generous in light of the company's slowing earnings growth.
The year-over-year revenue and earnings lift from Costco's membership fee hike peaked in the fourth quarter. This should have driven strong operating income growth given that membership fees account for the bulk of the company's earnings. Instead, operating income (adjusted for the extra week in fiscal 2017) rose less than 10% last quarter.
Over the past few years, the combination of a new credit-card deal, membership fee hikes, and tax reform drove strong EPS growth. Costco won't be able to rely on those levers for the next few years. Its square footage growth rate has also moderated recently. As a result, it's not surprising that analysts expect EPS to rise just 9% annually in both fiscal 2019 and fiscal 2020.
It's hard to justify buying Costco stock for nearly 30 times its projected fiscal 2019 EPS when it may not produce a double-digit EPS growth rate in the foreseeable future. Costco is certainly a solid company that is likely to continue growing at a steady (but not spectacular) rate for years to come. However, investors should probably wait for Costco shares to retreat to a more palatable valuation before considering buying the stock.
