When Amazon.com, Inc. (NASDAQ:AMZN) announced its intention to acquire Whole Foods in June, Costco Wholesale Corporation (NASDAQ:COST) stock fell off a cliff. It went from its all-time high of $180 to $150 in a month. Since then, COST stock has gradually climbed higher, but at just over $160, the stock remains well off where it traded prior to the Amazon/Whole Foods deal.
That smells like a buying opportunity to me. Due to its sticky customer base, unparalleled convenience and already low prices, Costco will be largely immune to any shake-up Amazon causes in the grocery sector. While Amazon’s acquisition of Whole Foods will likely steal market share from similar grocers like Sprouts Farmers Market Inc (NASDAQ:SFM), such market share gains will likely not eat into Costco’s market share.
Consequently, considering Costco is presently growing about as fast as it has over the past five years, COST stock deserves a valuation that is at least in line with its trailing five-year average valuation. That implies a year-end price target of about $180 for Costco stock.
Here’s how I get there.
Costco Largely Unaffected By Amazon
Amazon cut prices by a whole bunch at Whole Foods at the end of August, and Costco didn’t feel a thing.
Costco reported that September comparable sales were up 6.2%. That is better than August (up 5.9%) and July (up 5.3%). Essentially, in the face of lower prices at Whole Foods, Costco’s comparable sales growth actually accelerated.
If this trend continues, Costco stock will rebound because it symbolizes that fears related to Whole Foods are overblown.
I think it will continue. Costco has a particularly sticky consumer base. Members pay between $60 and $120 per year to get access to Costco’s low prices and all-in-one convenience.
These two factors differentiate Costco from other grocers. Costco’s average ticket is more than 2 times as large as the average ticket at a grocery store, so clearly, consumers are buying more than just groceries at Costco. It’s a one-stop shop for groceries, electronics, clothes, gas and more. Plus, Costco has some of the lowest prices on the market thanks to its membership model. They essentially sell their products at cost and rake in all the profit from membership fees. Consequently, lower prices at Whole Foods still don’t compare to Costco prices.
All in all, then, Costco is a totally unique shopping experience that will not be disrupted by lower prices at Whole Foods. The September sales report provided the first piece of evidence to support this claim. Subsequent sales reports will simply provide additional evidence.
The Numbers on Costco Stock
Fears are still baked into Costco stock, and that is an opportunity.
COST stock trades below its trailing five-year average price-to-earnings multiple. That lower multiple comes despite the future growth outlook being stronger than trailing growth. Since 2013, Costco has grown earnings around 7% per year. Over the next three years, earnings are expected to grow about 8% per year.
The trailing five-year average P/E multiple is 27.7. Higher forward-growth prospects imply that this stock deserves at least a 28-times multiple. A 28-times multiple on fiscal 2018 earnings estimates of $6.42 imply a year-end price target of about $180.
Bottom Line on COST Stock
Costco stock has been unfairly beaten up due to overblown concerns related to the Amazon/Whole Foods deal. The September sales report shows that Costco is performing quite well against lower prices at Whole Foods. As more sales reports file in and underscore the thesis that Costco is doing just fine, the valuation on Costco stock will normalize.
A normal valuation on current earnings estimates implies about 12.5% upside for COST stock over the next 12 months. I like that return profile, so I am buyer at these levels.
As of this writing, Luke Lango was long COST and AMZN.