Valued at $317 billion, Costco is among the most recognizable brands in the world. The big-box retailer has delivered stellar returns to shareholders, rising 239% in the last five years and 692% in the past decade. However, as past returns don’t matter much to current or future investors, let’s see if COST stock is a Buy at its current valuation now that it has dipped 9% from its high. I’m bullish on Costco due to its recession-resistant business, consistent and growing profit margins, and robust membership program.
An Overview of Costco
Costco operates warehouses and e-commerce websites offering members low prices on a selection of private-label products across categories, allowing it to benefit from high sales volumes and rapid inventory turnover.
Over the years, Costco has successfully combined operating efficiencies realized through volume purchases, efficient distribution, and reduced merchandise handling in warehouse facilities. Its high volumes and turnover allow Costco to operate profitably, even at lower gross margins.
Costco ended the January quarter with 875 warehouses, 603 of them being in the U.S. and Puerto Rico and 108 in Canada.
How Did Costco Perform in Fiscal Q2 2024?
Yesterday, Costco announced results for Fiscal Q2 2024 (ended in January). It reported revenue of $58.44 billion with adjusted earnings of $1.74 billion or $3.92 per share. Comparatively, analysts forecast revenue at $59.16 billion with adjusted earnings of $3.62 per share. In the year-ago period, the retail giant reported revenue of $55.27 billion with earnings of $3.30 per share.
While Costco beat earnings estimates, its sales were below forecasts, driving the stock 7.6% lower today.
Costco emphasized that traffic rose by 5.3% globally and 4.3% in the U.S., allowing comparable sales to increase by 5.6% year-over-year. As inflation cooled off, Costco was able to reduce prices on certain items. For instance, during the earnings call, Costco stated that product prices in categories such as sporting goods and gardening will move lower, as freight and commodity costs have normalized.
Online Sales Are Growing for Costco
Similar to other retail companies, Costco was forced to focus on growing online sales at the onset of COVID-19. In the last four years, Costco has made several changes to its website to improve the user experience for digital shoppers.
For example, it rolled out a new mobile application homepage last month, which loads in less than two seconds, significantly lower than its previous loading speed of eight seconds. Costco stated that the update in speed is crucial, as 60% of online sales are derived via the mobile application and the mobile browser.
In Fiscal Q2 2024, Costco grew its e-commerce sales by 18.4% year-over-year, much higher than the 12% growth experienced in the last two quarters. A widening base of online sales should be accretive to Costco’s profit margins in the upcoming decade.
Moreover, Costco rolled out Apple Pay to all existing members. It is also adding additional merchandise to Costco Next, a seller platform where members can purchase products such as electronics and apparel directly from suppliers at a discounted price.
According to Costco, online sales have gained pace, as the company has spent money on advertising that showcases the value of lower product prices for items such as appliances, tires, and mattresses. Total mobile application downloads in Q2 stood at 2.8 million, while cumulative downloads to date are 33 million.
Costco’s Membership Fees Are Key
Costco has a unique business model: you need to be a member to gain access to its warehouses. It charges an annual fee, which is beneficial to the retailer and shoppers. While shoppers benefit from discounted product prices, Costco’s membership sales allow it to lower prices generously, resulting in repeat purchases.
Costco has increased its membership count from 76.4 million in 2014 to 127.9 million in 2023. The annual membership fee is about $60 each year (or higher depending on the type of membership), allowing Costco to rake in $4.6 billion annually just via this high-margin product. Moreover, around 90% of shoppers renew their memberships each year.
Historically, Costco has increased its membership fees every five and a half years, last raising them in June 2017.
Costco’s Growth Story Is Far From Over
Costco has a significant presence in the U.S. and Canada and plans to open 31 stores this year. It entered China in 2023 and has opened six stores to date in the country. China represents a massive growth opportunity for Costco, given that it’s the second-largest economy in the world and still growing at a fair clip.
Despite its massive size, Costco is forecast to grow adjusted earnings from $14.16 per share in Fiscal 2023 to $15.90 per share in Fiscal 2024 and $17.17 per share in Fiscal 2025. Priced at 45x forward earnings, COST stock trades at a premium, given that the sector’s median multiple is much lower at 18x.
However, quality growth stocks such as Costco trade at a lofty valuation due to their pricing power, wide economic moat, and growing earnings.
Is COST Stock a Buy, According to Analysts?
Out of the 29 analysts tracking Costco, there are 21 Buys and eight Holds, indicating a Moderate Buy consensus rating. The average Costco stock price target is $755.69, indicating upside potential of 5.8% from current levels.
The Takeaway
Costco remains a solid long-term investment if you can look beyond its steep valuation. The retail behemoth should benefit from its expansion in China and other growth markets, which should drive membership fees and sales higher.
