In a market where retail stocks of all stripes have been hammered, Costco Wholesale Corporation (NASDAQ:COST) stock has been a notable outlier. Heading into the company’s fiscal third-quarter earnings report, Costco stock had gained 26% over the past year.
And though cautious/bearish analysts have pointed to slowing growth — including misses in both Q1 and Q2 — COST stock has continued to rise in 2017, gaining 12% YTD.
With Costco posting an earnings beat Thursday afternoon, COST stock has responded by gaining 2% in after-hours trading. Fears of decelerating growth were assuaged by a 5% company-wide same-store sales increase. The earnings beat wasn’t quite as big as headline numbers suggested, but margins still came in well above expectations.
More importantly, the quarter gives confidence to COST stock bulls who have stuck with the stock even after a pair of disappointing results. The Q3 numbers seem to show a company getting back to its historical outperformance. If that’s truly the case, Costco stock has a lot of growth — and a lot of appreciation — still to come.
A Strong Report for Costco Stock
In Costco’s fiscal Q3, revenue grew 5.4%, which was a bit over a point below analyst estimates. But it’s not clear the extent to that it is a modeling error.
Same-store sales excluding gas and currency were up 5%, which reportedly was above Street estimates. With membership fees the only real source of revenue left — and no surprise there, as Costco’s fee isn’t rising until next month — the cause of the divergence appears unclear.
Headline numbers aside, it does look like sales were above expectations … at least the part that Costco could control, as gasoline prices and currency impacts obviously are well beyond the company’s reach.
On the bottom line, earnings per share of $1.59 appear to have crushed consensus estimates of $1.31. Meanwhile, a 28% increase year-over-year suggests a sharp acceleration in growth. But Costco received a one-time 19 cents benefit due to its $7 per share special dividend
, inflating Q2 numbers. That aside, however, Costco still beat consensus by 9 cents, and grew EPS 13% year-over-year.
All told, Q3 looks ahead of expectations — and seems to support the bull case for COST stock. Comp growth of 5% and increased margins is exactly what the company needs to deliver. Few investors doubt the quality of Costco’s business. Rather, the valuation of Costco stock — over 30 times FY17 EPS — has been the concern. But if Costco can continue to perform as it did in Q3, the valuation will take care of itself.
Does COST Stock Have More Upside?
COST stock seems likely set another all-time high in trading Friday. Costco stock is up about 1.6% in after-hours trading — and from here, those gains look a bit light. There was a real fear that after weak first-half performance, Costco’s story was beginning to show some cracks. The business seems protected from Amazon.com, Inc. (NASDAQ:AMZN) — the bogeyman for all U.S. retailers at this point.
But weak comps in Q1 and a decline in net income in Q2 raised the concern that e-commerce was at the least taking some small amount of incremental sales from the business. Considering fixed costs in the business model, and the high valuation of COST stock, Costco didn’t need much e-commerce-driven erosion to see its stock price fall.
Those concerns seem somewhat mitigated coming out of Thursday’s earnings report. I don’t know that the quarter is quite enough to get Costco stock to $200 – but it’s enough to see further upside from current levels. Mid-single-digit same-store sales and double-digit earnings growth is what investors are used to from Costco. With the company again delivering on that front, investors seem to respond as they have for years now: by paying a higher price for COST stock.
As of this writing, Vince Martin has no position in any securities mentioned.
