Shares of mega-retailer Costco (NASDAQ:COST) dropped sharply after the company reported first-quarter numbers that didn’t quite live up to expectations. While revenues beat sell-side estimates, earnings came up short, and the theme of the conference call was intensifying margin pressures.

The report also came against the backdrop of a broader market being dragged lower by weak China data. That didn’t help. Overall, Costco stock dropped nearly 10% after reporting first-quarter numbers.

The dip in Costco stock makes sense. This stock was fully valued heading into the print. Any weakness would’ve caused shares to fall. But margin weakness is of the secular kind, and that’s why you are seeing a big sell-off in Costco stock.

But, just because the sell-off makes sense, that doesn’t mean it’s time to throw in the towel on Costco stock. Instead, this is a long-term winner adjusting to an era of lower margins. As the stock makes this adjustment, the near term will be turbulent. Eventually, it will find a floor and then head higher.

Investors might not have to wait long for Costco stock to a find a floor. Right around $200 seems like a fundamentally supported price, even assuming flattish margins going forward.

Margin Pressures Are a Negative

Costco’s first-quarter earnings report was a mixed bag. There was some good: Top-line trends are strong, comparable sales in the U.S. and globally remain robust and the e-commerce business remains red hot.

But, there was also some bad: Bottom-line trends are weakening. Namely, gross margins are drifting lower, and the headwinds weighing on margins likely won’t disappear any time soon.

The competitive landscape throughout the retail scene is now stiffer and more crowded than ever before. As a result, prices across the whole industry are naturally drifting lower, especially at the low end where the likes of Costco, Walmart (NYSE:WMT), Target (NYSE:TGT) and

Amazon (NASDAQ:AMZN) are all competing to have the lowest prices out there. Naturally, this price erosion is weighing on Costco margins. Considering that this competition is only picking up, price-related margin pressures are here to stay.

Moreover, Costco’s gross margins are being pressured by the e-commerce business. Digital sales carry lower margins than physical sales because they have fulfillment costs. Hence, as the e-commerce business grows, gross margins are dropping. This trend won’t ease any time soon either.

In other words, gross margin pressures are here to stay for Costco. That’s a big negative, and it’s why investors are re-thinking paying 30 times forward earnings for Costco stock.

The Fundamentals Remain Strong

In the big picture, aforementioned margin pressures are just piece in the entire Costco stock investment thesis.

On the margin front, margins are under pressure today, but not by much. Plus, gross margins have been largely stable and rising for the past several years, and the opex rate is still falling thanks to strong sales growth. Meanwhile, everything is firing on all cylinders on the sales front. Costco is reporting comparable sales growth that is as good as its been in recent memory. The e-commerce business is finally gaining material traction.

Let’s also not forget Costco’s secular advantages. This is a company with a huge and growing moat of Costco members who are loyal and big shoppers. Plus, the low-cost and all-in-one convenience nature of Costco are enduring positives — and attributes that hold up well during an economic slowdown.

As such, the fundamental drivers here remain solid.

Costco Stock Valuation Supported At $200

Given persistent margin issues, but still-strong revenue tailwinds, I’ve revised my model lower on the margin front to assume flattish gross margins going forward, but kept my revenue projections at mid-single-digit growth per year.

Under those assumptions, $12 in earnings per share feels reasonable by fiscal 2024. A historically average 26 forward multiple on that implies a fiscal 2023 price target of $312. Using a 10% discount rate, that equates to a fiscal 2018 price target of just over $200.

So, dips to $200 look like a good opportunity buy Costco stock.

Bottom Line on COST Stock

Costco has persistent margin issues which will keep this stock from shooting to the moon. But, in the big picture, the core fundamentals remain solid, and those strong fundamentals will power Costco stock higher from a $200 base.

As of this writing, Luke Lango was long COST, TGT, and AMZN.