There are very few stocks that haven’t taken a blow from the market meltdown triggered by the novel coronavirus outbreak . Costco Wholesale Corporation (NASDAQ:COST) is one stock that has remained stubbornly resilient.
In fact, Costco stock has moved 7% higher since the beginning of fiscal year 2020 and currently trades around $314. And there are bullish triggers that suggest further upside that makes the stock worth considering for fresh exposure.
I expect the market volatility to sustain even as ultra-expansionary monetary policies have supported equities. a defensive stock is worth considering in the current market scenario, and Costco stock has a beta of 0.75.
Another factor that makes Costco interesting is the dividend pay-out. After the recent dividend increase, the company’s annualized dividend is $2.80, quite attractive to income investors. Since 2004, the company’s annual dividend has grown at a compounded annual rate of 13%. Robust pay-out and sustained dividend growth is a positive trigger.
Costco is also interesting from a balance sheet and liquidity perspective. For the second quarter of 2020, the company reported cash and equivalents of $8.7 billion.
Further, with a debt-to-capitalization of 25.2%, the balance sheet is healthy. The company’s cash flow from operations for the last fiscal year was $6.4 billion. Positive free cash flows on a sustained basis is also a major positive.
I also like the fact that the company does not pursue share buybacks. It makes sense to preserve cash for uncertain times. The biggest U.S. airlines spent 96% of their free cash flow over the past decade on share repurchases. Now that hard times are here again, those same airline companies now require significant bailout assistance.
Steady Growth in Membership Revenue
For Costco, the key driver of cash flow is member fees. The positive point to note here is that the company’s paid membership has grown at a steady pace.
As of Q2 2020, the company’s paid members totaled 55.3 million households, compared to 44.6 million households in FY2015. For the last twelve months, the cash fees generated by Costco stood at $3.5 billion. Importantly, the company has a 90.9% renewal rate in U.S. and Canada.
From a growth perspective, the single biggest trigger is the company’s expansion in China. In the last financial year, the company opened its first Costco in China (West Shanghai). By opening day, there were 139,000 membership sign-ups. This is an indication of the potential the country holds for company growth.
A second store will be set-up in China’s eastern city of Suzhou. The warehouse store will have a area of more than 50,000 square meters. In the United States, Costco has 564 warehouses. With China being bigger in terms of size and population, Costco has significant impending growth potential.
Therefore, I expect steady growth in top-line, cash flows and dividends in the coming years. These are multiple bullish factors for Costco stock.
In the coming years, another growth trigger for Costco is likely to be e-commerce sales. Even after the coronavirus pandemic is contained, consumers will be relatively cautious in terms of visiting crowded stores. This will push e-commerce sales growth. Costco is already gaining traction on that front. For Q2 2020, the company’s comparable online sales increased by 28%. I expect this strong trend to sustain with the company launching e-commerce sites in Japan and Australia in the recent past.
The Bottom Line on Costco Stock
For the current financial year, the mean estimate for the company’s earnings per share is $8.72. At a stock price of $314.50, Costco stock is trading at a price-to-earnings-ratio of 36.0.
This may seem expensive, but I believe that as investors look for defensive stocks, a valuation premium is justified. In addition, the company has steady cash flow and dividend growth visibility. Once expansion efforts gains traction in China, Costco stock is likely to trend higher.
Therefore there are multiple reasons to be positive on COST stock, which seems attractive for income and growth investors.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with a focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.
