Wait for a Pullback to Buy in Costco Stock
Ashish is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Costco Wholesale Corporation (NASDAQ: COST) represents one of the world's best ran and most dominant retailers. Longer term we look favorably upon Costco's ability to successfully open new clubs domestically and abroad, while also utilizing its ever-strengthening merchandising expertise to capture share. However, in the near term we believe there is a limited stock upside. Costco now trades at a multiple at the high end of historical range. The combination of difficult same store sales comparisons and an already lean cost infrastructure, over-indexed to variable expenses limits the opportunity for substantial EPS upside at the chain. We advise investors to await a pullback in shares.
Near-Term Woes
The company reported July same store sale growth of 5% which was above the consensus expectation of 4.1%. The reported same store sales (SSS) beat the consensus estimates for the first time in 5 months.
However, we believe that many analysts may not have adjusted for the July 4 calendar shift, which positively affected the SSS by roughly 1%. Eliminating the calendar shift, SSS remained in the 4% range as was the case in June. Average ticket declined by about 1% during the month following flat to slightly positive growth in previous months. Though the soft lines category was up (mid-to-high single digits), but driven by small appliances and domestics rather than higher-margin apparel goods.
Core International same-store sales slowed to +7%, which is 100 bps lower than the average over the prior four months. The FX impact, which peaked in July 2011 at +260 basis points, continued to remain a drag at ~175 basis points in July 2012 which was higher than the trend over the prior four months average of 140 bps. Given the current environment, it is likely that FX impact will remain volatile and a headwind throughout the next few months.
No doubt there still remain incremental cost savings opportunities for the company. However, we do not foresee expense leverage at the chain to improve meaningfully over the next several quarters given moderating SSS trends. Compared with other retailers, Costco has a cost structure that is more variable in nature since it owns the majority of its real estate and rent represents less than 5% of SG&A compared with 15%+ at other leading hard-line retailers.
Thus, the company already has a very lean expense infrastructure and August SSS is expected to increase modestly in the low-single digit range reflecting a soft macro environment, a very promotional Back-to-School season, soft mall traffic trends, the lack of compelling new fashion trends for BTS season, and a challenging SSS comparison of +7.0% in August (vs. +6.6% in July).
Long-Term Growth In-tact
We believe the company has good long term growth prospects given its unique positioning in the retail market. Over the past five years, COST has been able to win customers with the quality if offers, the service it provides, and the deals it gives customers every day. This business model has allowed the company to bring its format to Australia and Asia over the past several years to boost its geographic footprint. Moreover, Costco does not belong in any one category of the retail sector. Neither can it be group with luxury retailers like Tiffany (NYSE: TIF) and Saks (NYSE: SKS) that have their own operating environment, nor can it be categorized in the same group as Dollar General (NYSE: DG) and Wal-Mart (NYSE: WMT) that may lose customers if there is a boom in the economy. Costco’s diverse product portfolio features both luxury and non-luxury goods and thus allows customers to trade up and down within Costco.
We suggest investors with short or intermediate-term investment horizons examine other well-positioned retailers like Macy’s and Coach which are trading below their historical range. Long-term investors who are looking to build up a position are advised to await a pullback in the stock prices in the coming 2-3 months before initiating a position.
TheAnalystBlog has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale and Tiffany & Co. 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.If you have questions about this post or the Fool’s blog network, click here for information.
