Costco (COST) reports fiscal Q2 2013 earnings before the bell on Tuesday morning, March 12, 2013. The analyst consensus expects $25.1 billion in revenue and $1.06 in earnings per share, for expected year-over-year growth of 9% and 18%, respectively. Quarterly comps are expected in a range of 5%-6%, and if January and February's monthly comps are reliable (which they are), Q2 2013 comps should be quite solid and in line with historical mid to high single digits.
Unlike a lot of other retailers, at least so far anyway, COST continues to report monthly comps probably because it continues to tell a good story. A comp usually consists of two components: monthly traffic and "average ticket," or basket, which attempts to capture how much store traffic is being sustained or even growing, as well as pricing power within the brand.
Traffic for COST has been excellent for some time and in Q2, according to the monthly comps, we saw the following traffic compares:
- Dec 2012: +5%
- January 2013: +3%
- February 2013: +4.5%
If you compare these numbers to other retailers, particularly Wal-Mart's (WMT) Sam's Club, it shows that COST continues to gain market share in the warehouse space.
Although we have remained long one position in COST since April 2005, we've been out of the majority of our position for the last 20% move in the stock, which hasn't been too smart. COST is currently trading at 23x expected 2013 earnings for 13% growth this year. The key metric in our opinion is cash flow, with COST trading at 12x cash flow and 20x free cash flow. If you go all the way back to the late 1990s, as our spreadsheet does, you will see that cash flow has grown on average about 13% per year.
COST's gross margin is around 12.5% and the operating margin varies between 2% and 3%, which has always left me very wary of the potential for small changes in expenses whacking EPS. Thus, I'd buy the stock at a better level. That said, management, even with the departure of Jim Sinegal, has been a bastion of operational efficiency. An article by research firm Trefis detailed how COST's revenue per square foot has risen from $804 in 2007 to an estimated $907 in 2012, and is expected to continue to rise.
The key element (in our opinion) to the fundamental story is that given cash flow and free cash flow, COST has a lot of room to repurchase more stock if it ever wanted to do so. According to our internal spreadsheet, the percentage of free cash flow used to "allocate capital" back to the shareholder is just 13%-15% since we began tracking in 2009. In other words, the current dividend and share repurchases represent just 13%-15% of COST's four-quarter trailing free cash flow for the last two to three years. (Compare this to WMT's current strategy of returning all or 100% of free cash to shareholders, and you see the potential.)
Our internal model values COST at $114 per share, while Morningstar puts a fair value on COST at $109. We think the stock is pretty fairly valued here, but its execution has been superb so there's no reason the stock can't work higher if the retailer meets estimates.
We would look hard at owning COST again in the low $90s depending on what drives the stock down to that level. We are trying to be patient and disciplined with the shares, and are waiting for the pullback.
We never tell readers what to do in terms of a particular stock. We put our valuation parameters and analysis out there for all to see and allow readers to draw their own conclusions. COST is a superb retailer. It's low-cost, has good brands, and we shop there frequently. However, we try to wait for lower-risk positions to own shares, and in my opinion COST really is not in that position yet.