Costco Wholesale (COST 1.01%) recently released its fiscal third-quarter results, and they weren't all that great. But wouldn't you know it, Costco's stock price jumped on the news.
That's because there was a lot more in the report than meets the eye. Costco has an all-weather model that beats out its competition in some crucial ways. These differentiating factors fuel Costco's excellent business and make it an attractive stock to have in your portfolio at any time.
1. You can't argue with low prices
Costco's business model involves charging customers an annual membership fee for the privilege of shopping at its warehouses, and then marking up products with a razor-thin margin to make the membership more attractive. The markup covers associated costs, and the membership fee goes to the bottom line.
Most companies talk about increases in gross margin as a positive feature, and update shareholders regularly in their quarterly reports about improved margins. Costco uniquely keeps its gross margin intentionally low since that draws traffic and generates sales. Compare its gross margin with those of Walmart and Kroger:
COST Gross Profit Margin data by YCharts
High volume allows it to negotiate better rates from suppliers, which it typically passes onto customers. This cycle results in higher sales, more members, strong membership renewal rates, and growing profitability.
In the third fiscal quarter (ended May 7), sales inched up 1.9% over last year. Earnings per share (EPS) were unusually lower, year over year, due to one-time charges related to ending a supply chain program it developed to get around logjams last year.
But membership fees increased from $984 million last year to $1.04 billion this year and accounted for 1.98% of sales vs. 1.91% last year. Renewal rates were at all-time highs of 90.5% globally and 92.6% for the U.S. and Canada, and membership increased 7% over last year.
Compare the same companies' profit margins. I would also point out the consistency here, despite the tumult of the beginning of the pandemic and ensuing challenges. That itself is an attractive quality in a stock.
COST Profit Margin data by YCharts
2. It has tons of room to grow
Incredibly, Costco still has tons of expansion opportunities. It operates 853 warehouses worldwide, with 587 of those in the U.S. It opens around 25 stores annually, which is a minuscule amount compared with the typical retailer. That trended lower over the past few years as the pandemic and supply chain issues impacted store openings.
Management is aiming to get back to 25 over the next five years, and then increase that to 30 new stores for the five years following. It still doesn't even operate in every U.S. state, and so it certainly has room to expand domestically.
However, international expansion looks even more exciting, particularly in the massive market of China. It recently opened its first store in that region, and plans to have five by the end of the year. As for their performance, CFO Richard Galanti said "They're doing great. End of story."
The near term looks like it will continue to be pressured. Many retailers rely on opening new stores to generate sales growth at times like these, and Costco could theoretically bump up growth if it decided to fast-track store openings. But Costco doesn't go for those kinds of plays. It stays steady and consistent, leading to success over the long term and market-beating returns for its stock.
Can it duplicate past success?
This isn't the first time I've said Costco is my top stock to buy, and it's done well during that time -- up 67% since early June of 2020.
Can Costco do it again? I would venture that it can. It's operating the same model it always does, only now its renewal rates are even higher than before. Plus, there are still massive expansion opportunities, providing the retailer a long growth runway.
And I haven't even mentioned the dividend, which yields 0.73% at the current price, but comes with the occasional special dividend that makes it quite lucrative. That's why even as sales growth is slowing to some of its lowest rates ever, Costco is still one of my top stocks to buy.
