Hold Costco For Now
Christopher is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Retail spending, excluding autos, was reported to have increased by 0.7% in January from December as against expectations of a rise of 0.6%. This better than expected result was helped by a cut in the result announced for December to –0.5% from a previously reported –0.2%. The retail environment is still on sticky ground, and firm gasoline prices are not likely to help it in the medium term. Further pressure is likely to come to bear on retail sales as wages find it difficult to keep pace with inflation, and high unemployment takes its toll.
Sales at general retailers were more positive in January than those at department stores, with an overall rise of 2% against 1%. Amongst these general retailers, Costco (NASDAQ: COST), the membership warehouse retailer, continues to star.
In its January sales release, Costco announced that its sales had increased by 11% and revenues at stores of more than one-year existence had increased by 8%. Competitor Target (NYSE: TGT), also reported strong numbers, though at 4.3% sales growth some way behind Costco.
At $84, Costco shares trade on a trailing price to earnings ratio of 25. With these earnings expected to increase by 16% in the year to August 2012 (to $3.86 per share from $3.32), the forward price to earnings ratio comes in at 19.33.
Chasing market share is reflected in the margins at Costco. An operating margin of 2.69% falls some way behind the 5.94% at Walmart (NYSE: WMT) and the 7.8% at Target. Profit margins follow suit at 4.3% at Target, 3.77% at WalMart, and just 1.61% at Costco. This said, revenue growth at Costco, with its far better sales increases, outstripped its main competitors in their last reported quarters. Quarterly revenue growth of 5.1% at Target compares with 8.1% at WalMart and 12.4% at Costco.
Costco has cash of $5.92 billion, and debts of $2.26 billion. While WalMart has more cash ($7 billion), its debt of $59 billion dwarfs Costco’s, as does Target’s $19 billion debt.
Costco shares have traded in a range of $78 to $88 since September 2011. This pattern looks likely to continue, though with a positive bias as investors become more reticent about risk.
Consumers, faced with a sluggish economy and wages that are not rising in line with inflation, seem to be increasingly cost conscious. Price sensitivity is a phenomenon that Costco’s management are well tuned to. Its willingness to accept lower margins has led to increasing market share and revenue growth that is leaving competitors in its wake. Whilst this increase in revenues is currently producing better earnings, pressure on those margins from higher gasoline and materials prices could pressure profit margins in the future.
Overall, this defensive play is fairly priced against its competitors. Narrow margins are a concern, though Costco’s management has proved it can produce positive results in a difficult and competitive market. At the present time, Costco deserves its premium rating over Target and WalMart, though results due on February 29 will give more clues as to management of its margins. I rate this stock a hold right now.
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