Investors who have bet on Costco (NASDAQ:COST) have been generously rewarded over the past year. COST stock reached new all-time highs in 2021, gaining more than 50% to $567.70 per share over the course of the year. But since the beginning of this year, Costco’s share dipped 13.6% to $483.47 per share in a tough market that retracted by 7.2% on the same period, as measured by the S&P 500 Index (NYSEARCA:SPY).
This underperformance compared to the broader market poses a question for investors already invested in this stock: is it time to reduce their exposure to the retail giant?
COST Stock’s Financials Are Vigorous but Poised for a Slim Deceleration
With the effects of the Covid-19 pandemic, Costco’s fundamental picture has significantly improved over the past few quarters. Net sales in its 2021 annual report showed double-digit growth, up 17.5% to $195.9 billion.
Going forward, the consensus of analysts expects net sales to moderately decelerate in 2022, up 10.9% to $217.2 billion, and to slow down even more in 2023, up 7.7% to $233.9 billion. On the other hand, net profit advanced 25.1% to $5 billion in 2021, but this robust increase is expected to decrease in speed in 2022. Analysts expected it to rise by 13.2% to $5.67 billion, representing a net margin of 2.61%.
Nevertheless, Costco’s constructive business cycle is not going to stop. The company recently published December 2021 sales figures, where it said it registered “an increase of 16.2 percent from $19.14 billion last year,” to $22.24 billion.
In addition, Costco’s balance sheet is healthy. The company’s net cash position is expected to bounce robustly in the next two years. Analysts are expecting a steep acceleration in 2022 and 2023, up respectively 53.3% to $5.77 billion and 41.4% to $8.17 billion. This comes after a steep decline in 2021, down 19.3% to $3.76 billion.
Similarly, Costco recently declared a quarterly cash dividend on Costco’s common stock of 79 cents per share, delivering a yield of 0.65% per year.
Despite the Dip, Costco Still Trade Above Its Peer Group
Even after the steep correction of COST stock, its market capitalization remains stretched compared to peers. The company is now trading at an estimated 2022 price-earnings ratio of 38x and at a 2022 EV/EBITDA of 21.7x. On the other side, Walmart (NYSE:WMT) — one COST’s best comparison points — has a more affordable valuation. It exchanges at 26.9x 2022e EPS and has a 2022e EV/EBITDA of only 11.1x.
Moreover, WMT posts an equivalent net margin and a yield of 1.6%, which is twice as high as Costco’s.
Another retail player that is comparable to COST and that has cheaper valuation metrics is Target (NYSE:TGT). With an estimated 2022 net margin of 6.3% and a 2022 yield of 1.4%, TGT’s 2022 estimated P/E and EV/EBITDA stand respectively at 16.1x and 9.7x.
COST Stock Deserves a Premium
Despite decelerating financials and overvalued valuation metrics, inflationary pressures should continue to sustain Costco’s sales. Macro-economic theory tells us that in an inflationary regime, consumers are more enticed to consume now, rather than postpone their purchases. Therefore, consumption is likely to continue to grow in the near term, which should sustain Costco’s overall sales.
Besides, COST’s pricing power is by far the highest of our peer retail group. This can be seen by calculating the cost as a percentage of revenues, which is equal to the markup (or gross margin) minus net profit, all divided by total revenue.
Source: Chart by Cristian Docan
As we can see in the above chart, Costco has a great ability to maintain steady costs. More importantly, its peers spend nearly 2.5x more to source their products.
Costco’s low-cost structure is a huge advantage in an inflationary environment because it provides better flexibility for the company to pass higher costs to customers without hurting too much profitability.
That being said, the wholesale retailer still trades at a premium compared to its peers after the recent correction, but COST’s stock valuation seems for me justified due to its robust growth figures, low-cost structure and pricing power flexibility.
In this context, I am bullish on COST stock and believe that investors looking to play this investment case should benefit from this dip to reinforce their positioning.
On the date of publication, Cristian Docan did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Cristian Docan, a contributor for InvestorPlace.com, has been writing stock market-related articles for Seeking Alpha, Stocknews, and Wealthpop since 2017. He takes a fundamental and technical approach in evaluating stocks for readers, focusing on momentum investing and macro-driven strategies.
