Better Than Expected Earnings Nudge Costco Valuation Up

Our $368 per share valuation of wide-moat Costco COST should rise by a low- to mid-single-digit percentage, reflecting the combined impact of the time value of money, expected ongoing near-term sales strength as the delta variant of the coronavirus runs its course, and a strong end to fiscal 2021 (ended Aug. 29). We continue to expect mid-single-digit percentage sales growth and 3%-4% adjusted operating margins once pandemic-related volatility eases, and suggest prospective investors seek a more attractive entry point despite our favorable view of the company and its competitive standing.

Costco posted $195.9 billion in full-year revenue (fueled by 13% comparable growth excluding fuel and foreign exchange), slightly behind our $196.3 billion target, though modestly better than expected profitability led to diluted EPS of $11.27 which beat our $11.15 forecast. The company’s fourth-quarter results (9% comparable growth excluding fuel and foreign exchange, flat operating margin at 3.6%) came alongside rising inflation, which management estimated at 3.5% to 4.5%. We are not surprised that Costco has hesitated to raise prices by a similar percentage as inflation, with the company committed to providing strong membership value and maintaining or expanding price gaps on products. We believe Costco’s business model affords it considerable flexibility in managing the present cost environment; as nearly 60% of its operating income comes from membership fees, it has room to price merchandise aggressively. Combined with tremendous cost leverage (borne of its scale and its concentrated assortment), we do not expect Costco’s value proposition to be derailed by a rising cost environment. However, despite our upbeat view of the company, we contend that the shares’ current price assumes near-flawless execution in an intensely competitive and turbulent retail environment, even as it increasingly relies on less-established international markets for growth.

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