We do not plan to make a large change to our $143 per share valuation for wide moat-rated Costco (COST) after the firm announced tepid first-quarter results. The company posted 1% comparable sales growth--2% excluding the impact of gas prices and foreign exchange--which trails our 3.8% full-year expectation. The firm’s operating margin also lagged somewhat, at 3.1% versus our forecast 3.2% full-year target. Despite the short-term challenges, we do not anticipate changing our long-term outlook, which calls for mid-single-digit revenue growth and 3.3% operating margins on average through fiscal 2025. We anticipate a slightly tempered short-term forecast will offset a time value of money adjustment, leaving our valuation little changed. The shares are trading somewhat above our valuation, likely due to our somewhat more conservative long-term margin growth view.
Deflation continues to pose a top-line challenge industrywide, with Costco reporting especially stiff headwinds in fresh food, gasoline, and certain electronic categories. The company’s tendency to pass cost savings on to customers quickly has accelerated some of the impact relative to Costco’s peers. For example, in November, the firm saw dollar meat sales increase 6% despite a 16% increase in pounds sold, despite wholesale-retail beef spreads that are near all-time highs (per U.S. Department of Agriculture data). We remain confident that Costco’s value proposition to its customers will improve as inflation returns across its product spectrum, as cost increases should underscore Costco’s price gaps against alternative outlets, strengthening its value proposition and driving top-line growth. In our view, the firm’s cost advantage underpins the firm’s brand intangible asset, creating a wide economic moat that protects consistent midteens returns on invested capital (15% on average since 2011; 17% average yearly projection through fiscal 2020).
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