Markets

Put Costco on Your 'To Buy' List?

The biggest wholesale club operator is well positioned to maintain its leading position -- just be prepared to pay a premium for its shares.

When the economy gets tough, penny-pinching consumers choose Spam instead of ham. They also tend to buy in bulk to save on grocery costs.

Both trends benefit Costco Wholesale, the warehouse-club giant. "Costco is better equipped to weather a recession than other retailers since food is 60% of its sales mix," says Stephanie Hoff, an analyst at Edward Jones.

If you invested in Costco a year ago, you're getting an even better deal that its 52 million shoppers. The stock (symbol COST), which closed at $66.62 on March 26, has climbed 21% over the past 12 months, handily beating Standard & Poor's 500-stock index, which lost 7% over the same period.

Costco is the biggest wholesale club operator in the country by sales, with about 530 stores in 40 states and a handful of countries. The stores carry about 4,000 items -- a fraction of the variety offered by rival discounters, such as Wal-Mart Stores (WMT) and Target (TGT). Costco caps mark-ups at about 14% above the cost of merchandise, well below that of other big retailers, which typically set prices at 25% to 50% above costs. Costco also provides financial services and sells gasoline.

The slumping economy is allowing Costco to upgrade its merchandise. Many companies that previously turned up their noses at the company's cavernous, non-descript warehouses are selling to Costco now that shoppers are spending less time and money at upscale malls. Among previously unavailable clothing lines that Costco started carrying recently, at prices well below those charged by other retailers, are Janzen, Hurley, Lucky and OshKosh.

Analyst John Gabriel of Morningstar notes that Costco also benefits from the decision of many retailers to freeze expansion plans. That gives Costco more choices and more bargaining power as it picks locations for new sites.

The Issaquah, Wash., company plans to open 16 to 18 new stores before the conclusion of its fiscal year, which ends on August 31. Longer term, chief executive Jim Sinegal says he's wants to double the size of the business over the next ten years.

Costco posted strong results during its second fiscal quarter, which ended on February 17. It said that customers visited its stores slightly more often and made larger transactions than in the same quarter a year earlier.

Helped by rising gasoline prices, revenues rose 12% from the year-ago quarter, to $17 billion, while sales from stores open a year or more rose 7% ((without the jump in fuel prices, the increase in U.S. same-store sales would have been 3%). Profits increased 31% from the same period a year earlier, and operating margins (profits from operations divided by revenues) expanded slightly, to 3% from 2.4%, as store productivity improved.

The number of new households signing up for membership jumped 11% during the quarter. That's an important figure because annual membership charges of $50 or so are vital to Costco's bottom line. Costco's 87% membership renewal rate reflects the loyalty of its shoppers. Membership fees totaled $343 million in the second quarter.

The company is taking other steps to boost profits. It has tightened its return policy for electronics and is looking to gain a bigger foothold overseas (it currently operates in Canada, Mexico, the United Kingdom, South Korea and Taiwan).

Costco is also getting a boost from higher sales of its private-label Kirkland brand. Sales of the in-store brand rose by more than $600 million over the past 12 months.

Naturally, there are some chinks in the bullish case for Costco. For starters, the stock is pricy. It trades at 21 times the average of analysts' earnings estimate of $3.08 per share for the 12-month period that ends in November. That compares with a price-earnings ratio of about 13 for the S&P 500 and an average P/E of about 16 for the stocks of major retailers. Costco's P/E is also well above the 13% annual earnings growth that analysts expect the company to generate over the next three to five years.

And Costco, of course, isn't just a purveyor of tilapia and toilet paper. The company acknowledges that the economic slowdown is affecting causing customers to hold off on purchases of big-ticket items such as jewelry and furniture.

Costco also faces heavy competition from supermarket chains, discounters and other warehouse clubs, such as BJ's and Wal-Mart-owned Sam's Club. And Costco's California stores account for more than 30% of its sales, so any major regional hiccup could hurt sales and profits.

But with little long-term debt and enough cash flow to support store expansion, Costco is well positioned to improve profits and maintain its leading position among warehouse stores. So don't just think of this big-box leader as a great place to go shopping. Think about putting the company itself on your "to buy" list.

Most Popular

8 Money Tips for Seniors Suffering from Inflation
Inflation

8 Money Tips for Seniors Suffering from Inflation

This year has been an especially tough one for seniors on fixed incomes. To stay on track, try these eight financial survival tips.
June 26, 2022
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
An Easy Way to Find How Much You Will Spend in Retirement
retirement planning

An Easy Way to Find How Much You Will Spend in Retirement

One simple math equation can help you determine where to start building your retirement income plan, and whether your money should last.
June 27, 2022

Recommended

Stock Market Today (6/28/22): Weak Data Opens Trap Door Under Stocks
Stock Market Today

Stock Market Today (6/28/22): Weak Data Opens Trap Door Under Stocks

Slack in manufacturing data and low consumer confidence tanked early-session optimism and left the major indexes with deep losses Tuesday.
June 28, 2022
Stock Market Today (6/27/22): Stocks Limp Out of the Starting Gate
Stock Market Today

Stock Market Today (6/27/22): Stocks Limp Out of the Starting Gate

Monday's session saw stocks give back a little territory from last week's rebound rally, but experts are seeing a few reasons to be optimistic.
June 27, 2022
Move Over ETFs: Direct Indexing Is an Investment Strategy Worth Paying Attention to
investing

Move Over ETFs: Direct Indexing Is an Investment Strategy Worth Paying Attention to

More flexibility, more control, the potential for higher returns and tax-reducing strategies: With pros like that, could direct indexing be right for …
June 25, 2022
Stock Market Today (6/24/22): Stocks Stick the Landing in Successful Short Week
Stock Market Today

Stock Market Today (6/24/22): Stocks Stick the Landing in Successful Short Week

Small hints that inflation might have peaked and that the U.S. might evade recession stoked broad buying Friday.
June 24, 2022