Morningstar | Costco’s Solid 3Q Results Do Not Surprise, but Shares Still Seem Rich
We do not plan a significant change for our $213 per share valuation for wide-moat Costco after its third-quarter earnings met our targets. We still expect mid-single-digit top-line growth and operating margins just above 3% in the decade ahead. We believe Costco is poised to continue its strong run, but see the shares’ trading price as assuming a degree of perfection with which we are uncomfortable.Costco saw 5.6% comparable store sales growth (excluding fuel price changes, foreign exchange, and the impact of an accounting standard change) against a 3.3% operating margin, consistent with our forecasts. With 8% revenue growth and a 3.1% operating margin year-to-date, our announcement full-year targets of 8% and 3.2%, respectively (and $8.04 in diluted EPS) appear to be in reach.
While the specter of increased tariffs looms over retail, we believe Costco is better suited than most to mitigate the impact. Costco magnifies its buying power by offering a limited assortment, stocking less than 4,000 distinct items in store versus around 75,000 for a retailer like Target. This allows Costco to concentrate its sales, creating significant purchasing power. We believe the firm can continue to bring this to bear in a rising tariff environment, working with vendors to either negotiate down the impact or find alternative sources. While a 25% tariff on an expanded roster of items should necessitate some price hikes, we believe Costco’s value proposition relative to conventional retailers would endure as its scale should allow it to hold increases down in such a scenario without a similar level of margin sacrifice.
All of Costco’s regions posted mid-single-digit comparable growth (excluding fuel and currency). We believe this bodes well as Costco increasingly looks beyond its home market for growth. While we think that Costco’s strength is somewhat less formidable outside the U.S., we believe its standing is improving, and that global growth feeds its purchasing leverage.
Costco Wholesale and its subsidiaries are principally engaged in the operation of membership warehouses based on the concept of providing its members low prices on a selection of nationally branded and private-label products. The company's merchandise are: food and sundries, which include dry foods, packaged foods, and groceries, snack foods, candy, alcoholic and nonalcoholic beverages, and cleaning supplies; hardlines, which include appliances, electronics, health and beauty aids, hardware, and garden and patio; fresh food, which include meat, produce, deli, and bakery; softlines, which include apparel and small appliances; and ancillary, which include gas stations and pharmacy businesses.
Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offer an extensive line of products and services for individual investors, financial advisors, asset managers, and retirement plan providers and sponsors.
Morningstar provides data on approximately 530,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 18 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. Morningstar also offers investment management services through its investment advisory subsidiaries and had approximately $185 billion in assets under advisement and management as of June 30, 2016.
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