Costco Wholesale (COST 0.17%) has long been an investor favorite.
The retailer has an easy-to-understand business model, a clear economic moat, and a track record of success.
The warehouse retailer has also been a strong performer during the pandemic, as it drew customers to its cavernous warehouses early in the lockdown era and has delivered strong results through much of this year as well.
However, Costco shares have slumped since the company issued a disappointing monthly sales report for November, and its year-to-date performance only just matches the S&P 500 index now.
Is Costco a buy heading into 2023? Let's take a look at where the company stands today and what investors should expect next year.
Costco today: Reliable results but signs of vulnerability
In its recently released fiscal first-quarter earnings report, Costco reported comparable sales growth of 7.1% adjusted for fuel and constant currency, and a modest increase in earnings per share from $2.98 to $3.07.
Many of Costco's peers, especially in the discretionary retail sector, are struggling, facing higher inflation and a shift in consumer spending away from goods and toward services like restaurants and travel that consumers didn't get to spend on during the pandemic.
Costco also has an advantage over the retail sector because its membership model insulates it from fluctuations in its retail business. In fact, Costco makes most of its profits from its membership income, bringing in $1 billion in profit in its most recent quarter, or 73% of total net income.
Membership trends at the company remain strong as well, as it said on the earnings call. Renewal rates clocked in at 92.5% in North America or 90.4% globally. Paid membership increased 7% over the last year, showing steady growth in customers, and the company saw faster growth in executive members, who pay double the fee and save an extra 2% when they shop at Costco.
The company also hinted on the earnings call that it was likely to raise membership fees, which it has historically done every five years, by $5.
Image source: Costco.
What to expect in 2023
2023 is still a couple of weeks away, but the new year looks set to get off to an inauspicious start for retailers like Costco.
November retail sales fell more than expected, down 0.6% from October, and a number of retailers have said that consumer spending noticeably slowed through October and November.
Those headwinds are also starting to show up in Costco's own results, as adjusted comparable sales rose 5.3% in November. While that might sound good, it's down from Costco's earlier comparable sales growth and also below year-over-year inflation at 7.1%, which could signal some margin compression, as Costco is likely paying more for the goods it sells.
With falling retail sales, the Federal Reserve's latest interest rate hike, and ample evidence that consumer demand is slowing, 2023 is shaping up to be a tough year for retailers, as the economy could sink into a recession.
While the company has some recession-proof characteristics, including its membership model and rock-bottom prices, the stock's recent slide shows that investors seem to be fearful of a recession.
Costco's biggest risk
Going into a potential recession, Costco's biggest risk isn't a problem with the business but a problem with the stock's valuation.
At a price-to-earnings ratio of 35, Costco is more expensive than nearly every other brick-and-mortar retailer, and its slowing growth doesn't bode well for its premium valuation.
If performance continues to weaken, Costco's multiple is likely to compress, and the stock could fall another 20% and still be considered expensive.
While the warehouse retailer has a rock-solid business, investors may want to wait for a pullback to buy the stock, as shares are pricey right now, especially considering the weakening economy.
