Trading at a Premium Yet Offering Growth

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The economy is in a revival mode. Consumers and investors who are always on the lookout for cheap products or investment options are extra cautious during this period. Here is a company that should interest both alike.

The recent results of Costco (NASDAQ: COST) were on the upside of analysts’ estimates in terms of both EPS and revenues. Costco, with its attractive pricing and round the year low margins, is competing fiercely with Wal-Mart (NYSE: WMT) and Target (NYSE: TGT), that generate a large percentage of their sales during the oncoming holiday season.

How Costco Does It

Costco keeps its prices low throughout the year thereby it’s in a position to keep its competitors at bay. The company’s upfront annual membership fee helps in generating a steady cash flow for the company and assures better wages for employees. The unique shopping experience that the customers get in the form of a plethora of food samples to test and choose from, better deals while shopping, and cheap food at its food courts; adds quality to their shopping and makes them Costco loyalists. Thus Costco has the foundation and the strategy to assure decent revenues.

Costco Is Good; But Worth Buying?

Costco is a promising company with growth of over 110 times in the last 20 years. The company is trading at a premium at its current prices with a PE of 25 and EV/EBITDA multiple of nearly 11x. It is not cheap for investors with a short term view, but for long term investors, Costco has a lot to deliver. The company at present has its major concentration in North America and Canada where it cannot potentially grow, but has tremendous foreign expansion potential with its Loss Leader policies. With Wal-Mart facing bribery allegations in Mexico and with ongoing investigations in Brazil, China and India, Costco has an opportunity to enter these markets.

Costco currently is performing well compared to its competitors as its same store sales grew by about 7% whereas Wal-Mart and Target reported the performance below expectations. Wal-Mart pointed inflation and deflation along with other macroeconomic factors to be the reason of the fall in same store sales. Costco seems to be managing itself better than its competitors through these troubles and uncertainties.

A Look Around

Wal-Mart faces criticism for its poor wage rates and labor laws and is steering through allegations of bribery in Mexico and investigations for its lobbying practice in India. The stock prices should take further hit due to disapproval of its policies in the US and Asia. The stock price seems to be currently undervalued as Wal-Mart’s P/E of about 15 is well below the industry P/E of 18.5. The company is currently trading below $70 while its fair valuation is about $99.50 with an EPS $4.86 and PEG ratio of 1.60. Investors should not forget that despite allegations Wal-Mart is the largest retailer and has been minting money for its investors since decades. This company is a good buy at its current prices.

Target’s same store sales are also falling, like Wal-Mart, and the market share is being well taken over by Costco as it’s the only retailer among the three that has shown growth in same store sales outperforming others. Target’s stock price performance has been good, but Costco and Wal-Mart both have outperformed it. Target has a fairly poor balance sheet with high debt levels and low cash flows. Target is making moves, like partnership with high-end retailer Neiman Marcus (though I do not think it will revolutionize shopping experience) to distinguish itself from its peer but things have got tougher for it with competition. The company is good but with an option to choose I will go with Costco and/or Wal-Mart rather than Target.

Foolish Final

Costco has a very successful business model which is doing well year over year. The company provides good dividend, buys back its shares and looks forward for ways to improve earnings. The company has a good retention of customers thereby having a good sustainable market to generate revenues. The share prices have fallen a bit due to the announcement of special dividend that is to be paid by taking a debt. The fall in prices has made a good entry point for long-term investors to BUY shares of Costco.

snehladha has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale. Motley Fool newsletter services recommend 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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