Should You Buy this Retailer?

ROUNAK is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

On Thursday, Costco (NASDAQ: COST) came out with its third quarter results announcing net income for the quarter at $459 million, or $1.04 per diluted share, as compared to $386 million or $0.88 per diluted share last year. Costco operates as a wholesale club retailer, selling at lower margins as compared to its competitors and charging a membership fee in return. The quarterly results are an endorsement to the significant growth the company has experienced over the past few years by establishing itself as a unique brand in the membership club retail business.

Recent numbers

Beating analysts’ expectations, Costco’s net sales for the quarter increased 8% to $23.55 billion, up from $21.85 billion last year against an estimate of $24.23 billion. This comes predominantly from the growth in its membership base, and as a result its membership fee collections. Membership fees go up to $110 for executive members who get 2% of additional benefits as rewards, while standard members pay only $55. The company also recently announced a quarterly pay dividend of $0.31 per share, a jump from the previous quarter dividend of $0.28 per share which indicate its steady returns.

Higher gasoline prices and foreign currency fluctuations have had a negative impact on the company's earnings. Excluding these effects, the company has grown at a rate of 7% over the quarter. Although the company has a price-to-earnings ratio of 25.07, which is substantially larger than its competitors, analysts have weighed in on the Costco shares and have increased their price target for the stock.

The growth in markets like Australia and Asia has been better than the growth in US. The company's business model has been welcomed positively internationally. As part of its international expansion policy, four of the five stores opened in the third quarter were in the markets of Japan, Mexico and the U.K. International markets are currently the most promising ones for every retailer. Costco plans to add another six locations in the next quarter.

Peers

The closet peers to Costco are Wal-Mart (NYSE: WMT) and Target (NYSE: TGT)Costco holds a significant position in retail, giving competition to the likes of Wal-Mart and managing to beat players like Target in terms of volume. Wal-Mart earned $3.78 billion, or $1.14 per share, in the first quarter, up from $3.74 billion, or $1.09 per share, a year earlier. Wal-Mart has been facing problems because of its diseconomies of scale, resulting in expensive goods and sending its customers fleeing to cheaper alternatives like Costco. The company’s current market is saturated and it is diversifying through e-commerce sales and operation in newer territories. Target, on the other hand, posted lower-than-estimated first quarter results and narrowed its annual outlook, citing soggy weather and higher taxes as the reason. Target earned $498 million, or $0.77 per share, which was down 40% from $697 million or $1.04 a share a year earlier. Costco presents the biggest threat to Target as its customers could buy the same goods at cheaper prices at Costco stores.

The future

What stands out about Costco is the fact that it has managed to grow and post better results in a turbulent economy that has affected its competitors severely. Costco has posted better-than-estimated results consistently, and its future strategies promise more of it. The company's efficient use of resources and its strong negotiating power with vendors show in its cheaply-priced goods with margins as low as 15% over it cost. Because of which, Costco has seen a noticeable increase in its membership base when more than 4 million customers joined in 2011. The company says it plans to open more than 30 stores this fiscal year, highlighting its ambitious growth plans. Moreover, the apparel industry, which has been severely down and which majorly contributes to Wal-Mart’s and Target sales, forms a very small portion in Costco’s sales. Another positive, Costco has a surprisingly low cash conversion cycle where it manages to sell inventory even before it has to pay its vendors.

The company has also realized the potential of the e-commerce sector working through its revamped website Costco.com and its applications for mobile devices. Costco offers distinct products in its stores and on its e-commerce platform to keep its customers interested and avoid overlapping among the distinct channels. The company is also betting heavily on its private label brands which have been a major driving force in its sales. It promotes these brands as cheaper alternatives to the other more established ones.

The warehouse retail sector has been growing with the reduced spending power of consumers and their increasing bargaining tendency. This explains the persistent climb in Costco’s share prices. The shares have risen 194% over the past ten years to reach $110 a share. Costco has a price-to-earnings ratio that is sufficiently larger than its peers and might seem overpriced at a glance. Given its extensive business plans, excellent competitive position, stellar past numbers and analysts’ positive outlook, however, the company's stock promises steady returns. The expanding sector puts the company in a commanding position, offering a nice investment opportunity.

Costco's low prices haven't just benefited customers -- shareholders have walloped the market, returning 11,000% over the past two decades. However, with prices near all-time highs, is the ride over for Costco investors? To answer that and more, The Motley Fool's compiled a premium research report with in-depth analysis on Costco. Simply click here now to gain instant access to this valuable investor's resource.


ROUNAK KHEMKA has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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