Costco Still Offers Value – WSJ


Costco


COST -1.20%

clearly offers great value for its customers. But what about for investors?

That question looms large for prospective buyers of the stock, which now commands a price-to-earnings ratio more than double that of the S&P 500 index, exceeding even glamour stock

Netflix.

More to the point, it is 15% pricier than its own not-modest 10-year average. That encompasses high expectations and might be part of the reason why, despite better-than-expected earnings, Costco’s shares declined 2.4% after the market close on Thursday following its earnings call.

One point of disappointment might have been Costco’s coyness about a membership-fee hike. Competitor Sam’s Club recently announced a fee increase, and Costco is due for one too. In recent history, that has occurred every five years and seven months. Costco Chief Financial Officer

Richard Galanti

said on Thursday’s earnings call that Costco had “no specific plans on a fee increase at this time,” though he reminded participants that the next five-year, seven-month mark isn’t until January 2023.

Remarkably, the share of consumers willing to shell out even more for a Costco membership has only grown as prices for everything else has increased. In a spring survey conducted by Jefferies, 48% of Costco members said they are willing to pay more for their memberships, an increase from 38% a year earlier. Corey Tarlowe, equity analyst at Jefferies, estimates that a fee increase at Costco would raise U.S. and Canada earnings by a low-single-digit percentage in each of the next two fiscal years compared with a scenario without an increase.

Not that Costco needs to pull that lever: The retailer has managed to increase U.S. comparable-store sales (excluding the impacts of fuel prices and foreign exchange) by an average of 12.2% over the past nine quarters. In the quarter ended Aug. 28, Costco’s U.S. same-store sales, excluding fuel and foreign exchange impacts, grew by 9.6% compared with a year earlier. No other big-box retailer has been able to grow so quickly and consistently. Meanwhile, members have remained loyal. Costco said Thursday that renewal rates reached all-time highs of 92.6% in the U.S. and Canada and 90.4% worldwide in the most recent quarter. The number of paid household members increased 6.5% year over year to 65.8 million.

Remarkably, Costco’s operating margins last quarter were 3.5%—just a hair below the 3.6% seen a year earlier during a time when other retailers have faced significant margin pressure. Part of that is a built-in advantage. Because Costco has limited offerings—fewer than 4,000 stock-keeping units in stores—but buys huge volumes, employees tasked with purchasing goods have a lot of knowledge on cost components involved in a product, giving them bargaining power, Mr. Galanti said. He added that there has been a rebound in Costco’s travel business—a smaller revenue driver that contributes a lot to margins.

In many ways, today’s inflationary environment has been an ideal one for Costco, whose customer base leans higher income. Its customers are feeling squeezed enough that they have become value-conscious, but not so much that they need to forgo all discretionary purchases. Consumer-electronics sales, for example, were actually up slightly compared with a year earlier, even as sales in that category declined for other retailers such as

Target

and

Best Buy.

It doesn’t need this environment to continue, though: Costco’s comparable-store sales have grown through all kinds of economic backdrops in the past, including the 2007-09 recession.

The coming months might provide another test of that resiliency. As the market digests the Federal Reserve’s latest messaging—that it will tolerate economic pain to tamp down inflation—investors are likely to stick with defensive stocks such as Costco. Meanwhile, it still has that membership-fee hike in its toolbox.

Costco’s shares aren’t cheap, but like its members, investors are inclined to stick around even if they get a bit pricier.

Costco is one of the biggest and most successful retailers in the country. In this video, WSJ’s Sarah Nassauer dissects the wholesaler’s unique approach to doing business. Photo: Qian Weizhong/Zuma Press

Write to Jinjoo Lee at jinjoo.lee@wsj.com

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