Costco Wholesale (NASDAQ:COST) certainly has important strengths, including its fast revenue increases, its loyal and growing customer base, and its high profitability. Still, given the shares’ relatively high valuation and important long-term threats facing COST stock, I recommend that long-term investors sell the shares.
Also, importantly, I believe that other large retailers are better positioned for the current macro environment than Costco.
Recognized Strengths Have Fueled COST Stock Gains
The retailer’s strengths are well-known on the Street (and reflected in the relatively high valuation of COST stock). That valuation includes a price-to-earnings ratio of 48.2. Meanwhile Walmart (NYSE:WMT) shares are trading at 29.8x last 12 months earnings and the Consumer Staples Select Sector SPDR Fund (NYSEARCA:XLP) sports a P/E of 20.6. COST shares are the second-largest holding (10.64%) in that exchange-traded fund’s 33-stock portfolio.
In a nutshell, as I mentioned earlier, Costco is growing rapidly, while its profits are impressive. In the first half of Costco’s fiscal year, the retailer’s earnings per share was $5.90, up from $4.76 during the same period a year earlier. (The first half of the company’s fiscal year ended on Feb. 13).
Last quarter, the retailer generated $1.8 billion of operating income, a 35% year-on-year increase from $1.34 billion. And its U.S. comparable sales, excluding gas inflation, in the company’s second quarter that ended in February, climbed 11.3% year-over-year.
Also importantly, in Q2, Costco’s “membership fee income” jumped nearly 10% YOY to $967 million. Moreover, there are multiple reports that, during the worst periods of the pandemic, Costco and its peers did a great job of signing up many “young families” to memberships.
Coronavirus Easing Will Likely Bring Problems
As CNN explained, during the pandemic’s darkest days “many consumers… made fewer trips to stores to minimize potential exposure to the virus, but loaded up when they were inside and spent more. This played right into the hands of warehouse clubs, which specialize in selling giant packages of ketchup, toilet paper and cleaning wipes.”
But of course, those days appear to be over now. No longer are most consumers intent on limiting their shopping excursions. Consequently, having a Costco membership may not be such a high priority for tens of millions of consumers in the U.S. and other countries in which the retailer operates. So, many members may not renew, in turn causing the growth of the company’s top and bottom lines to decelerate.
Another important point I believe is that with fears of the coronavirus fading, many consumers will be looking to have fun shopping experiences and socialize, rather than primarily shopping to fulfill their needs. That’s because I think its clear that, in the wake of the lockdowns and fears about the virus, there’s a sizable, pent-up demand to socialize and have fun experiences among many Americans.
I’ve only been in Costco stores a few times, but my experiences there and my research for this article suggest that consumers go to the warehouse locations primarily to meet their needs and save money, not to socialize and have fun experiences.
I think it’s clear that other retailers, including Ross Stores (NASDAQ:ROST) (where my wife often goes to shop and enjoy herself), Macy’s (NYSE:M), Bed, Bath and Beyond (NASDAQ:BBBY), Gap (NYSE:GPS), and Victoria’s Secret (NYSE:VSCO) are much better positioned to create fun experiences for consumers than is Costco.
E-commerce Presents Another Potential Achilles’ Heel
Costco is also far from the forefront of another important modern trend: e-commerce. The company likes to tout the fact that its e-commerce revenues are growing. For example, for Q2, CFO Richard Galanti reported that the retailer’s e-commerce sales had climbed 12.6% YOY. That gain, he noted, came after a 75% YOY increase in the prior quarter.
But compare those numbers to the performance of Target (NYSE:TGT), whose online sales nearly tripled from $6.79 billion in 2019 to over $20 billion last year.
And in 2021, digital sales accounted for nearly 19% of Target’s sales, while e-commerce came in at only about 6% of Costco’s sales in 2020, the year in which the worst of the lockdowns occurred.
Given these statistics, I think that Costco could lose market share if, as is likely, shopping for essentials online becomes much more popular in the medium-to-long-term.
The Bottom Line on COST Stock
COST stock is trading at a trailing price-earnings ratio of more than 48. That’s a fairly high valuation for a conventional retailer. GAP stock is trading at 23.1x and TGT is at about 16x.
Moreover, Costco Warehouse looks poised to be hurt by a few important macro trends. As a result of these issues, I recommend that longer-term investors unload COST stock.
On the date of publication, Larry Ramer held a long position in ROST stock.
