Costco Wholesale (COST 1.01%) is an iconic retailer with locations around the world. But its business model is vastly different from most retailers, which has given it an edge during both good times and bad. The stock is currently in a downdraft, which should interest long-term investors looking for a growth-oriented stock priced at a discount.
Costco's up-and-down numbers
Since hitting a high point in 2022, Costco's shares have declined roughly 18%. That may not seem like much of a drop, but it is deeper than the decline the shares experienced during the bear market in 2020 when the coronavirus pandemic had people working from home and practicing social distancing. When investors look at growth stocks, however, occasional drawdowns like this can present attractive entry points.
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To be fair, it wouldn't be right to suggest that Costco is a screaming value right now. Its price-to-sales ratio is just a little higher than the five-year average on that metric. And the retailer's price-to-earnings ratio is a touch below the longer-term average. So, roughly speaking, the stock appears to be fairly valued.
A fair price for a good company is attractive if you expect it to continue to grow its business over the long haul. And that seems highly likely when you consider Costco, which is a retailer with a very attractive business model.
Join the club
Most retail stores let anyone come in to shop. Costco, and other warehouse club stores, don't. They make you pay a membership fee for the privilege and, in return, provide attractively priced products to keep you coming back for more. Often the prices are well below what you could find at other retailers, though the selection is highly curated (and limited). Those fees, however, make a huge difference for the company even if its low prices lead to thin margins.
When you look at most retailers, their income statements have a single revenue line showing the value of what the company sold. That line exists on Costco's income statement but along with it is a line for membership fees. Product sales dwarf the membership fees collected, but keep in mind that there's really very little cost associated with the membership fees. In fact, after a person signs up, that income is kind of like an annuity. Product sales have to be juxtaposed against merchandise costs and selling costs.
Some figures will help. In the fiscal second quarter of 2023, which ended Feb. 12, merchandise sales totaled $54.2 billion with merchandise costs of $48.4 billion and selling costs of $4.9 billion. If you do the math on that, profits from selling products totaled around $900 million. That's nothing to sneeze at, but membership fees were roughly $1 billion, meaning that these fees made up more than half of the company's $1.9 billion operating income.
The interesting thing here is that those fees arrive no matter how well or poorly the actual stores perform, highlighting that the company has a nearly 93% renewal rate. And every new store is an opportunity to add new members, further enhancing the fee-derived income Costco generates. The company opened 23 new locations in fiscal 2022 and is planning another 24 in 2023. In other words, more membership fees are on the way.
Good company, fair price
As noted, value investors probably won't find Costco a compelling investment today. But then the stock is rarely, if ever, cheap. Growth investors willing to pay a fair price for a good company should probably see the current drawdown as an opportunity to put some money to work. In fact, even for value folks, it's worth learning more about Costco's business and putting it on your wish list. You never know: The market might hold a flash sale for some odd reason, and you wouldn't want to miss the opportunity.
