Costco (NASDAQ: COST), a warehouse club operator, gained roughly 30% – increasing from about $292 at the beginning of 2020 to around $380 currently. Costco has been firing on all cylinders during the pandemic as more consumer dollars got directed toward goods rather than experiences. As far as e-commerce goes, Covid-19 has given the retailer a chance to build out its own business. E-commerce revenue grew 50% in fiscal 2020 (year ended August 2020) and climbed another 65% through the first nine months of FY2021. In addition, the company has the lowest markup in the industry which creates an extremely compelling value for members. To add to this, the acquisition of logistics company Innovel Solutions should also help Costco increase its sales of big-ticket items in the years ahead. That said, the company is showing plenty of opportunities with a wide variety of inventory, omnichannel capabilities, and discounted prices to keep expanding going forward. We discuss more in the sections below.
But is this all there is to the story?
No, not quite. Despite the company’s stock rally, Trefis estimates Costco’s Valuation at about $403 per share, around 6% above the current market price based on two key opportunities.
The first opportunity we see is Costco’s Revenues growth over the coming years. Costco’s sales have surged almost 9% year-over-year (y-o-y) in fiscal 2020, as consumers frequented warehouses to stock up on essential goods, such as toilet paper, cleaning supplies, and food. In fact, the company is doing even better now with an 18% y-o-y rise in revenues so far in fiscal 2021. It should be noted that Costco was able to grow sales by 22% from the prior-year period and comparable-store sales at 15% in the recent fiscal third quarter – despite a gradual reopening happening across the U.S.
Costco has a business that thrives in both good and bad economic times. Costco collects fees from its members and sells items in bulk at rock-bottom prices while making most of its operating margin from these membership fees. This is despite the fact that these fees account for only 2% of the company’s total revenues. Moreover, it passes on cost savings to consumers by eliminating overhead costs like a salesperson and ornamental buildings (a business model oddly well-suited to the current economic times). Looking ahead, we expect the strong sales momentum to enable the retailer to reduce operating expenses as a percentage of sales, in particular because the company ended its $2 per hour pandemic-era premium pay sometime ago.
The second key opportunity stems from Costco’s valuation multiple compared to its peers. The stock now trades at a premium of 38x its projected 2021 earnings per share of about $10.60, per Trefis estimates. This is higher when compared to its peer, Walmart, trading at 26x forward earnings. However, we believe that Costco deserves this premium in multiple, given the strong revenue growth it has posted over the past years, and a trend that is expected to continue going forward. For perspective, Costco’s revenue grew 8% between 2017 and 2020, compared to about 3% growth for Walmart over the same period. While we acknowledge that Costco’s revenue base of nearly $167 billion (in FY2020) is much smaller compared to around $559 billion for Walmart, still the growth Costco has posted is meaningful. Now, if we were to look forward, Costco’s revenues are expected to grow 11% over the next two years, compared to only a marginal growth expected for Walmart.
While the bottom line expansion has been quite similar for both the companies between 2017 and 2020 at around 12% CAGR, Costco’s earnings are expected to grow 13% over the next two years, compared to the 11% growth expected for Walmart. As such, we believe Costco deserves to trade at a premium over its peers, and we believe its current P/E multiple will be appropriate for the stock. Our price estimate of $403 for Costco stems from a 38x P/E multiple and $10.60 in earnings per share in 2021. This implies around a 6% premium to the current market price of $380.
E-commerce is eating into retail sales, but this might be an investment opportunity. See our theme on E-commerce Stocks for a diverse list of companies that stand to benefit from the big shift.
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