What should investors make of the recent drop in Costco (NASDAQ:COST) stock?
The big box retailer, which has traditionally been a reliable investment, has seen its share price fall 12% during the month of May. At its trough on May 20, COST stock was down 24% before recovering to now trade at $471 a share.
But even with a rally in the final week of the month, Costco’s share price is currently sitting 25% below its 52-week high of $612.27 a share.
This raises the question of whether investors have turned on the members only grocery retailer, or if Costco is yet another great company that has simply been unable to avoid the market downturn this year that has accelerated during April and May?
Costco just reported its latest financial earnings on May 26. And while the Seattle-based company managed to beat Wall Street expectations on both the top and bottom lines, the results did show that its margins are under pressure due to rising freight and labor costs.
Specifically, Costco reported a decline in its gross margins, saying soaring freight and labor costs hurt its overall business. The margin squeeze played into the narrative at other major retailers such as Walmart (NYSE:WMT) and Target (NYSE:TGT), which reported big earnings misses due to higher input costs and continued supply chain disruptions.
COST stock fell along with all retailers after Walmart and Target’s disappointing earnings spooked investors and caused a stampede away from the sector. News that Costco’s margins are tightening in the current inflationary environment added further pressure to the company’s share price, pushing it lower.
Yet, the headlines about the slumping margins obscured the fact that Costco still delivered solid quarterly results that show the company continues to operate at full tilt. Costco’s revenue rose 16% to $52.6 billion in this year’s first quarter, compared with estimates of $51.55 billion. Earnings per share (EPS) came in at $3.17, which beat forecasts for $3.03.
In a conference call with analysts following its Q1 print, Costco said it is raising prices in certain areas to help offset the impact of inflation that is running at a 40-year high in the U.S. However, the company has shrewdly kept the price of its popular hot dogs at a $1.50, and its gas prices below the national average, both of which have helped membership levels rise this year.
And Costco has telegraphed that the price of its two tiers of membership, the $60 Gold Star and $120 Executive levels, could increase later this year.
With the bulk of Costco’s profits coming from its membership model, any increases could boost the company’s revenue and help it to remain resilient against the ongoing challenges it faces with inflation, labor costs, and supply chains.
In addition to its comparatively lower gas prices and cheap hot dogs, Costco also continues to attract customers with its private-label discount brand called “Kirkland.” Net sales of Kirkland products at Costco’s more than 800 retail locations increased 16.3% to $52.6 billion its most recent quarter. Costco says it remains on track to earn $200 billion in revenue this year for the first time in the company’s 46-year history.
The Bottom Line
Costco remains one of the best companies in the world, with a unique membership driven business model that is the envy of the retail sector. Despite experiencing some margin pressure, the company continues to report brisk sales and is taking steps to ensure that it not only retains current members but adds new ones by offering discounted gasoline and other perks to consumers who are looking for deals.
With pricing power to spare and plenty of customer loyalty, Costco can easily weather the current difficult economic environment and emerge stronger on the other side. For these reasons, investors shouldn’t worry about the recent downturn in the company’s share price. COST stock remains a buy.
On the date of publication, Joel Baglole 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.