Shares of Costco Wholesale Corp. (COST, Financial) are nearly flat since the beginning of the year compared to a return of 12% for the S&P 500 Index.
Part of this can be explained in that Costco's stocked gained more than 28% last year as consumers flocked to the company's stores to stock upon everyday items during the worst of the Covid-19 pandemic.
The stock now looks pricey on a historical valuation basis as well as its intrinsic value as determined by GuruFocus.
That being said, Costco, while not cheap, has a strong business model and impressive same-store sales that make the stock deserving of a high multiple.
A look at earnings results
Costco reported earnings results for the third quarter of fiscal 2021 on May 27. Revenue grew 21.7% to $45.3 billion, the highest year-over-year growth rate in at least five years and $971 million above what Wall Street analysts had expected. Net income of $1.22 billion, or $2.75 per share, compared very favorably to net income of $838 million, or $1.89 per share, for the same period of the prior year. The most recent quarter includes a 9 cent per share headwind from higher employee wages, but this won't be an issue in future quarters as the higher wage program has ended. Earnings per share was also 23 cents better than expected.
Year to date, revenue is up more than 15% while earnings per share have increased 27.5%.
For the third quarter, same-store sales grew 20.6%, which is higher than the growth rate so far for the fiscal year. Excluding the impact of gas and currency exchange, comparable sales improved 15.1%, topping consensus estimates of 12.7%.
All regions of the company saw double-digit comparable sales growth, even when adjusting for the impact of gas inflation and a weaker U.S. dollar. The U.S., Canada and Other International divisions had same-store sales increases of 15.2%, 16.7% and 13.1%.
Store traffic improved 12.5% globally while average ticket size improved 1.8%. Numbers were better in the U.S. at 2.7%.
E-commerce continues to perform very well, growing 41.2% for the quarter. This channel's two-year stacked growth rate is more than 100%.
Costco is also seeing gains in its membership fees, with this business increasing nearly 11%. Total household memberships improved 900,000 to 60.6 million quarter over quarter. Total card holders were higher by 1.5 million and paid executive memberships increased 817,000 to 24.6 million.
Worldwide renewal rates declined 10 basis points sequentially to 88.4%. U.S. and Canada renewal rates were 91%, matching the previous quarter's figure. This renewal rate also includes China for the first time. The company stated that first-year renewal rates aren't as strong as later years, so this should be more of a tailwind as Costco gains traction in the country. Without China, worldwide renewal rates would have inched higher by 0.1%.
Costco's balance sheet speaks to the quality of the company. At the end of the quarter, the company had $57.3 billion of total assets, including $27.9 billion of current assets and $10.2 billion of cash and equivalents. Inventories were higher by 14% to almost $14 billion, but this seems reasonable given the level of consumer demand that the company has experienced. Total liabilities were $40.3 billion, with current liabilities of just under $28 billion. The company does have approximately $7.5 billion of long-term debt, but just $92 million of debt matures within the next year.
Gross margins decreased 35 basis points to 11.2%, primarily due to gas inflation. The company did control expenses and selling, general and administrative costs as a percentage of revenue was lower by 107 basis points to 9.4%.
Takeaways and catalyst for growth
Costco delivered excellent same-store sales and e-commerce growth for the quarter. This mark would be less impressive if the prior year had seen weaker numbers, but this wasn't the case. Excluding gas and foreign exchange, comparable sales were resilient, led by an 8% improvement in the U.S.
A strong showing in foot traffic, higher ticket sizes and an increase in membership fees demonstrate that consumers find Costco's stores and products appealing. In particular, the higher ticket sizes in the U.S. are a positive note due to the solid numbers reported in the same quarter a year ago and because 559, or 69%, of the store base is located in the U.S. and Puerto Rico.
China should be a new growth market for Costco. Today, the company has just one store in the country, but this number is expected to grow in the coming years, including an additional opening by the end of the calendar year.
Another avenue for growth, perhaps the most important one, is e-commerce. As stated above, Costco's e-commerce has more than doubled over the last two years as the company has made this a prime focus. Costco Logistics, formerly known as Innovel prior to the company's purchase in 2020, has really accelerated Costco's entrance into online shopping markets.
Costco Logistics handled 70% of big and bulky orders in the U.S for the company. These items, which include appliances, consumer electronics and furniture, made up 53% of total e-commerce sales in the quarter. The build out of Costco's e-commerce business has decreased the delivery time for big and bulky items from two weeks to five to seven days for most items. These items are also now being shipped more straight from the vendor as opposed to a store location first, cutting down on shipping delays and costs to consumer.
Leadership did discuss inflation on the conference call. Previously, the company felt that inflation would be between 1% to 1.5% for the year, but now sees inflation, outside of gas, between 2.5% to 3.5%. Some examples included pulp and paper items, up 4% to 8%, and protein, which is up 7%. Beef was up 20% alone in the month of May. With many companies, in a variety of industries, reporting expected increases in the pricing of goods, this will be something to watch going forward.
Valuation
Analysts surveyed by Seeking Alpha expect the company to earn $10.60 per share for fiscal 2021. This would be a 14.8% improvement from the prior year. Costco closed Friday's trading session at $378.27, giving the stock a forward price-earnings ratio of 35.7. This compares to the stock's five-year average price-earnings ratio of 29.5.
Costco's forward price-earnings ratio is a premium to its historical average, but shares have rarely been cheap, providing evidence that the market has been willing to pay a high multiple for the company's growth rates.
GuruFocus finds shares to be trading at a slight premium to the stock's intrinsic value.
Costco has a GF Value of $346.43, giving shares a price-to-GF Value of 1.09 and a rating of fairly valued. The stock might be overvalued relative to its own history, but GuruFocus, by way of its intrinsic value calculation, finds Costco to be less overvalued. Shares would need to decline 8.4% to trade at the GF Value.
Final thoughts
Costco's most recent quarter has begun to lap Covid-19 impacted results, with nearly every quarter going up against double-digit gains in revenue in the prior year. A drop off in business might be expected as last year saw an unprecedented amount of consumer buying, but the third quarter just showed that Costco is still operating at a very high level.
The company also has several growth levers that it can continue to pull, including e-commerce and expansion, especially in China. Costco's stores are beginning to return more to normal, including the reintroduction of food samples and demonstrations and the reopening of food courts, that should draw in even more customers.
Dividend income investors should find the company's dividend growth streak of 18 years attractive even if the yield is less than 1%. The company often provides a high level of dividend growth, including a 12.9% increase for the payment distributed on May 14.
Shares of Costco might be expensive, but the company's execution and growth rates are undeniable, which makes the valuation more accepted in my view. Investors looking for a growth name in retail should consider buying Costco.
Disclosure: The author maintains a long position in Costco.
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