Costco Delivers Mixed Q2 Results

Our $332 per share valuation of wide-moat Costco COST should not change much after it announced second-quarter earnings. Its sales growth outpaced our target (12.9% adjusted comparable expansion across the company versus our 12.0% mark), but we expected cost leverage on the heightened revenue that did not materialize (25 basis points of operating margin degradation, to 3.0%, rather than our forecast for 25 basis points of improvement). As the double-digit sales growth is attributable to the pandemic and the margin shortfall to freight and fuel pressures we see as transitory, we continue to expect mid-single-digit percentage sales growth and 3%-4% operating margins over the next 10 years. We suggest investors await a greater margin of safety, as Costco faces an uncertain normalization of spending habits once the pandemic ebbs (later this year, we assume).

Costco’s fuel business exerted roughly 30 basis points of pressure on its gross margins, reflecting higher gas prices that tend to reduce profitability. Although the impact of such sales can be volatile, we continue to believe Costco garners significant benefit from its fuel centers, which promote regular traffic from customers drawn to low per gallon prices.

Costco started to lap the first days of the pandemic’s sales surge late in the period; a roughly 17% comparable growth performance in the first three weeks of February was brought down to a 13.8% mark for the full period, reversing a similar impact in February 2020 from the initial stock-up phase. The lingering effects of the pandemic should soften the blow, and we do not expect customers will abandon their newfound crisis-era habits completely. E-commerce should retain much of its recent expansion, an acceleration of past trends. While we believe Costco’s core value proposition will remain in store, its 76% quarterly e-commerce growth bodes well, bolstered by its integration of recently acquired Innovel (renamed Costco Logistics) to optimize bulky item delivery.

Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.