While the market continues to grind higher, Costco Wholesale Corporation (NASDAQ:COST) stock is in the middle of its biggest losing streak in recent memory.
It all started on Friday, June 16, when Amazon.com, Inc. (NASDAQ:AMZN) announced it was acquiring Whole Foods Market, Inc. (NASDAQ:WFM). The prevailing fear in the market is that Amazon will do to the grocery market what it has already done to mall retail. The internet retail giant will leverage its Prime ecosystem to cut prices to a point where competitors can no longer compete. If Amazon successfully executes, traditional grocers stand to lose significant market share.
With good reason, then, traditional grocer stocks like Kroger Co (NYSE:KR) and Sprouts Farmers Market Inc (NASDAQ:SFM) have fallen hard.
But, COST stock fell, too, and continues to fall today. COST is now down 11.5% since June 16.
That doesn’t make much sense. Raymond James upgraded Costco stock early last week, and this could prove to be a turning point in investor sentiment. COST stock is a “buy the dip” situation, and the time to buy the dip is now.
Why Costco Is a Safe Bet
At one end, COST stock is a scary place to be right now. There seems to be one word driving stocks up and down, and that word is Amazon. That’s a bad thing for Costco. After all, Amazon does exactly what Costco does, just online.
Both companies offer goods essentially at cost and make money through subscription revenue. Costco has a more diverse selection of goods, but with the acquisition of WFM, Amazon is inching closer to being just as robust as Costco.
At the other end, though, COST stock is an extremely safe place to be. Unlike traditional grocers and mall retail players, Costco has a sticky user base. Consumers pay $60-$120 per year just to be able to shop at Costco. They travel far and wide to be able to buy goods, load up on gas and grab a bite to eat, all in the same place and at an affordable price. The company’s low-cost, wide-selection business model means the consumer stickiness, which has developed over several years, won’t just wash away because Whole Foods gets cheaper.
Regardless, it isn’t of critical importance whether some consumers start shopping for more groceries at Whole Foods. Costoco doesn’t really make money from selling groceries — COST makes about 75% of it’s money from memberships. Because the consumer base is so sticky, that money isn’t really at risk.
Consider this: it’s estimated that nearly half of Costco’s members also already have an Amazon Prime membership. Clearly, the two can coexist. Amazon will have to do a lot more than just cut grocery prices in order to materially erode the Costco membership base.
Bottom Line on COST Stock
From a valuation standpoint, I really like the stock here. At 27-times trailing earnings, COST stock hasn’t been this cheaply valued since late last year when it was trading around $145 per share. The share price rallied off that bottom to above $170 per share by March. That’s a big, near-20% run up in just a couple months. We believe the current dynamics are similar, and that the stock is positioned for another strong multi-month run higher.
Costco doesn’t make much money from selling goods at mark-up. It makes money selling memberships, and that business will hardly be affected by Amazon’s acquisition of Whole Foods.
The market is misinterpreting this, which makes COST stock a compelling “buy the dip” situation here.
As of this writing, Luke Lango was long COST, KR, and AMZN.
