Is Costco a Good Value?
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
My wife asked me the other day what I thought about us getting a Costco (NASDAQ: COST) membership. Her real question and the question I am sure many potential Costco members ask; is it worth the $55 a year membership? Having never really thought much about Costco I thought I would dig into the company a little bit and then try and see if I could do a little analysis to see if we are just better off spending those 55 dollars at Wal-Mart (NYSE: WMT) like we usually do.
What surprised me about Costco the most was its sheer size. It’s the second largest retailer in the US and seventh largest in the world thanks to their over $90 billion in annual sales. They have 600 warehouses worldwide including 433 in the states. While they do operate worldwide, it is interesting to note that other than Mexico they do not have a Latin American presence as these markets are served by PriceSmart (NASDAQ: PSMT) which was spun off to focus on these operations. Still, they have tremendous growth opportunities ahead, especially in Asia.
Costco’s financials are in terrific shape. The $38 billion dollar market cap company has about $5.8 billion dollars in cash and equivalents against $2.3 billion of debt or nearly 10% net cash on the balance sheet. Their earnings are growing nicely and are predicted to continue that trend with an estimated 16% growth in 2012 and 13% in 2013. They pay a small but growing 1% dividend and have been buying back shares at a clip of about a billion dollars per year over the past half-decade. They generate around $2 billion in free cash flow which gives them a twenty times free cash flow multiple.
Costco has 65.7 million members covering 36 million households with an 89% renewal rate. These members are paying that $55 annual fee I mentioned earlier for access to their cavernous warehouses filled with shopping treasure. Costco works very hard to keep prices low in order to keep their customers happy. There is a great story from the upcoming CNBC documentary called The Costco Craze where the show’s host is interviewed on the Motley Fool Money Radio Show. Costco has been selling the same hot dog and soda combo in their food court for a buck fifty since 1985. When their hot dog supplier said they could no longer supply them at the current price, Costco went and bought a plant and learned how to make hot dogs in order to keep the price static for their members. An article on CNBC.com showed that a consumer who spends an average of $150 per week on groceries could save $2,344 a year by shopping at Costco. Costco does a great job creating value for their members and that $55 annual fee can easily be earned back as Costco is relentless in their pursuit of keeping costs down.
I mentioned earlier that one of the biggest challenges for a potential Costco member to overcome is paying that $55 annual membership fee. For my wife and I it's always been easy to just walk into a Wal-Mart to pick up whatever we need. Like a free checking account at a local bank or free parking at a local eatery we'd rather not pay for something that can be accessed for free elsewhere. For year's we've passed by the Sam's Club right next to our local Wal-Mart because in our mind we can get access to most of those same products right next door. What Costco has done, more so than Sam's Club is to play up on the exclusivity to the higher end customer who still wants a good value. This has helped them gain access to a customer who not only has money to spend but will spend more if they think they are saving more. The numbers speak for themselves, Costco is cashing in on this very profitable customer base.
I came away very impressed with Costco the company, but I’m just not impressed with Costco the stock. Trading at 25 times earnings for a company that’s only growing those earnings by half that amount just doesn’t excite. I like my stocks either as cheap as the products sold at Costco and paying a hefty dividend or in the early stages of their growth phase. I think that today you are paying a fair price for Costco but I am much more interested in owning PriceSmart. I do however think the Costco membership is a no-brainer but I’ll pass on the stock for now.
Motley Fool newsletter services recommend Costco Wholesale, PriceSmart, and Wal-Mart Stores. The Motley Fool owns shares of Costco Wholesale, and Wal-Mart Stores. latimerburned owns shares of PriceSmart and has a diagonal call on Wal-Mart. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.