Stock Analysis & Ideas

Costco Stock: Worth Accumulating on Corrections

The global economy is going through a phase of uncertainty. Factors such as inflation and geopolitical tensions are likely to impact growth. However, there are certain sectors of the economy that are relatively immune to economic shocks. The retail sector is a good example, with the United States economy being driven by consumption spending.

From an investment perspective, Costco Wholesale (COST) looks like an interesting pick from the retail sector. In the last 12 months, COST stock has been a value creator with returns of almost 70%.

I remain bullish on the long-term outlook for the company. However, it makes more sense to accumulate the stock on corrections.

Let’s talk about the factors that make Costco worth keeping on the investment radar.

Strong Growth and Cash Flows

Costco stock trades at a forward price-to-earnings ratio of 44.5. To some extent, the high P/E is justified by the company’s growth trajectory.

For Q2 2022, Costco reported revenue growth of 16.1% to $50.94 billion. Further, for the first half of the year, revenue growth was 16.4%.

Another point to note is that for Q2 2022, earnings per share growth was 36% to $2.92. This implies a forward price-earnings-to-growth ratio of around 1.24x if it keeps up that growth rate. Clearly, the stock is not significantly overvalued.

From a growth perspective, another metric that stands out is comparable sales growth. For Q2 2022, Costco reported comparable-store sales growth of 14.4%. In the e-commerce segment, comparable sales growth was 12.5%. With Costco building a strong omnichannel presence, it’s likely that comparable-store sales growth will remain healthy.

Growth in Recurring Revenue

Ultimately, a business is valued considering its cash flow potential. As of Q2 2022, Costco reported 114.8 million total cardholders. In the United States and Canada, the company has a healthy renewal rate of 92%.

Currently, Costco generated $4 billion in membership fees in the last 12 months. Also, for the first half of 2022, the membership increased by 10% on a year-over-year basis. Cash flows from membership fees will likely continue to swell in the coming years. One reason to expect membership fee growth is the expansion into new markets.

For example, Costco has just two warehouses in China. The country is home to 1.3 billion people, and it provides ample scope for member growth as Costco expands.

Another reason is the general expansion in footprint. In December 2020, Costco was present in 803 locations. The company’s presence has increased to 828 locations as of December 2021.

With the pandemic likely to shift to an endemic, the pace of warehouse addition is likely to accelerate. With a wider footprint, the company will be positioned to increase its membership fee revenue.

Wall Street’s Take

Turning to Wall Street, Costco has a Strong Buy consensus rating, based on 12 Buys and four Hold ratings assigned in the past three months. The average Costco Wholesale price target of $581.07 implies 5.1% upside potential.

Concluding Views

As of February 2022, Costco reported cash and equivalents of $11.8 billion. Further, for the first half of its Fiscal 2022, the company generated nearly $3.7 billion in operating cash flow. The financial flexibility discussion is important for two reasons.

First and foremost, Costco currently offers an annual dividend of $3.16 per share. Given the earnings growth and cash flow potential, COST stock looks like a quality dividend growth stock to consider.

Furthermore, Costco has the robust financial flexibility to pursue an aggressive expansion and investment in boosting supply-chain infrastructure.

Costco spent nearly $1.5 billion in the first half of Fiscal 2020 for capital investments. In the current year comparable period, the investments have increased to nearly $1.8 billion. Besides comparable-store sales growth, new warehouses will also boost earnings growth in the coming years.

Considering these factors, COST stock looks attractive. However, considering the upside momentum in the last 12 months, it might make sense to consider fresh exposure after a correction.

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