Costco Wholesale Corporation (NASDAQ:COST) fell about 4% on Friday after its fiscal second-quarter earnings report came up far short. And worse: COST stock might have a lot more downside left.
Costco earned $1.17 per share, on revenues of $29.77 billion, for the quarter ending in January. Analysts had been expecting earnings of $1.36 per share. $29.88 billion.
Even at its present level, COST stock is pricier than any other traditional retailer. Its price-earnings ratio is still above 30, almost double that of Wal-Mart Stores Inc (NYSE:WMT), the world’s largest retailer, and higher than even Alphabet Inc (NASDAQ:GOOGL). The market cap at $78 billion is almost two-thirds of its annual sales, while other retailers are fortunate to get a price of half their sales. Most now trade at 40% of sales due to fears over the growth of Amazon.com, Inc. (NASDAQ:AMZN).
Costco stock, in short, has gotten ahead of itself and was due for a pullback.
Costco’s Q2 Earnings
Costco’s profits are usually equal to the membership fees it collects from customers, and this time it fell short of even that mark. During the quarter, it reported membership fees of $636 million and net income of just $515 million.
Costco wrote that it plans to increase those membership fees in June, by about 10%, meaning executive members will be paying $120 per year for the privilege of shopping there. Canada was the star of the report, with sales increasing 8%, while other international sales fell 2%. U.S. sales rose 3%, which is how sales rose overall.
COST succeeds by selling in bulk, by demanding the lowest prices from suppliers, and by operating on wafer-thin margins. Its gross merchandise margins are about 13% — half the margins at discounters like Walmart, and this keeps customers (like me) incredibly loyal, willing to drive long distances to load up on the savings.
Costco grew its store count aggressively in the last few years, but that is showing signs of slowing. It was opening 30 new stores a year a few years ago, but Costco Addict, which tracks the company’s openings, counts only 16 new stores this year in the U.S. and Canada.
New stores are very expensive to open. The company reportedly opened 29 new outlets in fiscal 2016, with capital expenditures of about $2.65 billion.
Have We Reached Peak COST Stock?
What investors should be asking now is whether we may have hit peak Costco.
Costco is, by its nature, a slow-moving and slow-growing company. Revenues were about $118 billion in fiscal 2016 and have come in at about $57 billion so far in fiscal 2017.
The seasonality of its revenue stream shows it peaking in the spring, like Home Depot Inc (NYSE:HD). The fourth quarter of 2016 saw revenues of over $36 billion. But Costco’s year-over-year growth is still only in the low single digits.
COST stock bulls today will be pointing to the increased membership fees, and these should mean more earnings over the next few quarters, but the company may be reaching a limit on growth there. It has just gone through a transition from American Express Company (NYSE:AXP) credit to a Citigroup Inc (NYSE:C) labeled Visa Inc (NYSE:V) card, so it can’t expect earnings acceleration there, either.
While some investors who have seen Costco’s value double over the last five years are going to be grabbing what they think is a bargain today, Costco stock is not a bargain compared with other retailers, it’s not growing rapidly, and it might well disappoint over the next year.
I sold my own stake in Costco a few months ago, although even with the pre-market drop the, shares are still priced higher than where I sold them. So what do I know?
What I do know is this: Beware falling prices.
You may be better off shopping at Costco than buying COST stock.
Dana Blankenhorn is a financial and technology journalist. He is the author of the sci-fi novella Into the Cloud, available at the Amazon Kindle store. Write him at email@example.com or follow him on Twitter at @danablankenhorn. As of this writing, he was long AMZN and GOOGL.