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Morningstar | Costco Should Be Able to Stem the Competitive Tide That Is Roiling Retail, but Shares Seem Rich

We are lifting our valuation of wide-moat Costco to $213 per share from $192, reflecting strong second-quarter earnings, solid sales growth to date in the third-quarter, and the time value of money. We still expect mid-single-digit top-line growth against adjusted operating margins just above 3% over the decade ahead. Despite the increase, we see the shares as a bit rich.

While we believe prevailing share prices assume a degree of perfection with which we are uncomfortable, we still see Costco as one of the premier retailers in our coverage universe, capitalizing on its value-oriented concept and a strong management team. We expect its value proposition to endure even as retail undergoes its ongoing digital transformation, with its warehouse-style stores, aggressively priced merchandise, and often-bulky items at tight margins warding off digital rivals. Costco’s membership model features robust renewal rates (roughly 90%) and, as membership fees account for roughly 70% of its operating income, the company can slash the prices on the items it offers to members.

Costco’s tremendous operating efficiency (with sales per square foot topping $1,200 in fiscal 2018, well ahead of the other retailers we cover) is enabled in part by its focused assortment. By holding the number of items it offers in store down (to less than 4,000 versus around 75,000 to 80,000 at Target), Costco can concentrate its buying power, achieving procurement leverage that fuels the low prices that keep its membership base robust and store traffic high.

While it still has opportunities for growth domestically, we believe Costco’s growth will increasingly come from new and existing markets abroad. We expect the chain to build to around 1,000 stores over the decade ahead, and while its non-U.S. member base is somewhat less devoted, we foresee improvement as consumers become familiar with the club concept. In all, we see mid-single-digit member growth over the decade ahead, near its recent marks.

Although the retail landscape is relentlessly competitive, we expect Costco’s increasing scale should leave its standing relatively unchanged over the years to come, leading to our stable moat trend rating. While we expect Amazon to continue to grow and disrupt retail through a combination of aggressive pricing and fast shipping, we believe Costco’s efficiency and focused assortment will allow it to hold its own.