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Stock Analyst Update

Leading Competitive Edge Keeps Costco Solid

We're increasing our fair value estimate for the wide-moat firm.


Wide-moat  Costco’s (COST) third-quarter results place the firm moderately ahead of our full-year estimates, and as such, we intend to increase our $173 fair value estimate by a low-single-digit percentage. While we haven’t wavered on our thinking that Costco has amassed a sustainable competitive edge (as supported by renewal rates which exceeded 90% in the U.S., up from 87% a year ago), shares trade more than 10% above our valuation, and we’d suggest investors await a more attractive risk/reward proposition. The firm’s top line grew 12% (on top of 8% growth last year), driven by a 10.2% comparable-sales increase (5.1% traffic and 4.9% ticket). Further, operating margins held flat at 3.3% (against our flat full-year estimate of 3.3%). In an operating environment where a number of its peers are chalking up profit compression, we think Costco's results support our contention that it maintains a strong cost position within the industry.

While e-commerce remains a small piece of the firm's business currently (at less than 5% of sales), we view its growth in this channel (up 36.8%, on top of the near 20% last year) as evidence that Costco can cater to the changing consumer shopping habits that are gravitating online. These efforts also extend to its omnichannel experience (order online/pick-up in store), which management qualitatively mentioned as driving more consumers into the store. This omnichannel cycle may also increase the firm's brand awareness, which can help support its grocery delivery (both dry and fresh). Although nascent, we think the firm's expansion in this category (to all 520 U.S. warehouses by the end of the year) will also support its e-commerce (and sales growth) efforts (although details are sparse still). In the aggregate, we don't intend to alter our long-term outlook, calling for 6% top-line growth and 3.5% operating margins (which compares with its five-year average of 3.1%, as we incorporate increased economies of scale).

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John Brick, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.