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Better Buy: Costco vs. Target

By Robert Izquierdo - Mar 27, 2020 at 7:40AM

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These retail titans are in the midst of uncertain times. Learn which is the better buy right now.

Entering 2020, both Costco (COST -0.48%) and Target (TGT -0.26%) were among the select list of retailers showing success amid the retail apocalypse. However, the start of the COVID-19 pandemic injected a new twist into the 2020 trajectory of these companies.

As the coronavirus situation escalated, the well-publicized consumer hoarding of toilet paper meant Costco and Target experienced coronavirus-related sales spikes. On the flip side, both must now contend with reduced in-store foot traffic as many consumers remain home.

These abrupt changes in consumer behavior might shed some light on the resilience of each company. Let's examine what can be learned about each from the current environment, and how it provides insights into which might be the better buy.

Miniature shopping cart with packages for shipping on top of a laptop.

Image source: Getty Images.

Costco's uncertainty

Because Costco reports sales on a monthly basis, we've already gotten a glimpse into the coronavirus impact in its February results. For Costco's four-week reporting month of February, ended March 1, 2020, the company saw a 13.8% increase in sales over last year. Costco indicated a noticeable uptick in sales in the fourth week of the month, which the company attributes to consumer coronavirus concerns.

Contrast this with the company's second-quarter results for the 12 weeks ended Feb. 16, which encompass the Christmas holiday season, where the company saw 10.5% sales growth. February's surge in sales will carry into March -- but then, as consumers choose to stay home, the impact to Costco will be uncertain. On the earnings call, CFO Richard Galanti stated that it will be "hard to quantify what the financial impact will be" of the coronavirus pandemic.

With many consumers staying home, Costco will rely more on e-commerce sales. In that area, Costco announced the acquisition of Innovel Solutions for $1 billion on March 17. Innovel provides delivery services, specializing in large, bulky items like appliances.

Costco isn't known for its e-commerce strength, but it has done well. Its second-quarter results saw a 28.4% jump in year-over-year e-commerce sales. February saw 22.6% year-over-year growth. Subsequent months will reveal how well Costco's e-commerce operations can deliver sales amid shifting consumer behavior.

Despite the coronavirus pandemic, Costco's business is solid. Its second-quarter revenue was $38.3 billion, up from the previous year's $34.6 billion. Its net income was $931 million, up from $889 million. On top of that, Costco is a dividend-paying stock, and its membership model provides a recurring revenue stream. There is certainly a lot to like about Costco. Even if its overall sales softened due to declining in-store foot traffic, the company is likely to return to revenue growth after the pandemic passes.

Target's confidence

While Costco has been open about its uncertainty, Target believes it's in a position to maintain growth. The company stated expectations for a low-single-digit increase in comparable sales in its fiscal 2020 guidance. This guidance factors in the coronavirus pandemic, according to comments made by CFO Michael Fiddelke during Target's March 3 earnings call to discuss fourth-quarter results ended Feb. 1, 2020. The guidance is in-line with the company's pre-pandemic comparable sales growth of 1.5% in its fourth-quarter results. And on March 12, Target confirmed payment of its dividend, maintaining the consistency that allowed it to achieve Dividend King status.

The company's confidence comes from Target's optimization of the omnichannel shopping experience. It spent billions on renovating stores, but the renovations are only part of the picture. The company also built a strong e-commerce operation, which includes a drive-up option for purchases ordered online, a useful feature during a pandemic. Its efforts are paying off -- digital sales grew 20% year-over-year in the fourth quarter.

Moreover, Target built up a range of proprietary brands to capture higher profit margins, and it introduced a loyalty program last October. The company created a seamless shopping experience across online and offline segments that's flexible enough to meet the needs of its customers.

This translated into last quarter's revenue increase of $23 billion from the previous year's $22.7 billion. Its net earnings for the quarter were $834 million, a solid 4.4% year-over-year growth. Also, its fourth-quarter operating margin increased to 5.1% from 4.9% a year ago, a positive sign for a consumer discretionary stock like Target. 

The final verdict

Both Costco and Target are solid companies, so is one a better buy? Target's omnichannel strategy and confidence in continued growth amid the uncertainty of the coronavirus are impressive. Costco is still building out e-commerce capabilities, as its Innovel acquisition shows. Even so, its membership model is durable, and the company possesses solid financials, even if the pandemic reduces sales in the short term.

All things considered, a sound business model powered by memberships, consistently strong sales performance, and an e-commerce business with room to grow ultimately make Costco the better long-term buy in this matchup.

Robert Izquierdo owns shares of Target. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
$540.67 (-0.48%) $-2.61
Target Corporation Stock Quote
Target Corporation
$166.13 (-0.26%) $0.43

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