Costco Earnings Preview: Fairly Valued, But Traffic And Share Gains Are The Gifts That Keep On Giving

| About: Costco Wholesale (COST)

Costco (NASDAQ:COST) reports its fiscal q3 '13 earnings before the bell on Thursday, May 30th.

Analyst consensus is looking for $1.03 in earnings per share (EPS) on $24.2 billion in revenues for expected year-over-year growth of 11% and 17%, respectively.

Quarterly comps are expected in the 4%-5% range. April comps continued to be strong at +6%, driven almost entirely by traffic.

Last quarter COST grew revenue 8%, operating profit 15% and EPS 23% as membership fee income grew 15% year-over-year.

Both the expected quarterly EPS and revenue estimates have been stable for some time, although the fiscal 2013 and 2014 annual EPS estimates have been tracking steadily higher.

Anyone attempting to say COST has been fairly to over-valued the last 3 years has quickly been made a liar, as the stock has been a monster performer, up 16% year-to-date (YTD) in 2013, and up 18.5% in 2012, and none of these returns include the dividend.

In the brutal year that was 2011, where the SP 500 was up just 2%-3%, COST rose 15%.

So What Is COST Doing Right?

1.) Mid-single-digit to mid-teens revenue growth for the last 4 years;

2.) Low teens to high teens EPS growth the last 4 years;

3.) Mid- to high- single-digit comps driven by traffic and market share gains;

4.) Stable margins, driven by Kirkland (private-label) and occasionally high-end brands;

5.) Secular growth: per a note out of Trefis, dated May 7th, 2013, "A Breakdown of Costco's Business and Key Drivers", the warehouse business has grown 130% in the U.S. over the last decade, with COST steadily gaining share during that time;

What Do We Worry About?

1.) As an operator, COST is second to none, but the recent departure of founding CEO Jim Sinegal gave us a pause; although operationally, COST hasn't missed a beat since Jim left.

2.) The valuation: at 15(x) cash-flow COST is trading at a cash-flow multiple that we've seen previously, only briefly in 2008 and 2007.

3.) Forward EPS and revenue estimates for fiscal years 2013-2015 are estimates of 14% to 11% EPS growth and 11% to 7% revenue growth for a stock with a 22(x) multiple currently.

4.) The membership income fee hike of a year ago, the first in many years, will make for tougher revenue comps in 2013.

However, to be clear, anytime we've been worried about valuation since the stock traded in the mid $80s, we have been wrong.

We've followed COST for years, and the one thing people don't realize is that the warehouse clubs operate on razor-thin margins. The operating and net margins for COST since 1997 have averaged 2.50% and 1.69%, respectively (per our internal spreadsheet).

Dividend And Share Repurchases

COST's dividend payout ratio is still around 20%, where most retailers are around 30%-35%, which could be a function of COST's continued favorable growth prospects, but COST could be buying back more stock, too. Here is a table of the historical dividend payout ratio and the percent of COST's free-cash-flow being returned to shareholders over the last 4 years. (COST paid a special $7 per share dividend at year-end 2012 to beat the hike in tax rates.)

COST's dividend payout ratio and capital returned as % of free-cash-flow
Qtr end


Payout ratio

Capital Returned to

s/holder as % of free-cash-flow

2/13 661% (spec div) 205% (special dividend)
11/12 29% 43%
8/12 20% 56%
5/12 31% 56%
2/12 27% 65%
11/11 30% 54%
8/11 22% 53%
5/11 33% 60%
2/11 26% 54%
11/10 29% 58%
8/10 21% 52%
5/10 31% 43%
2/10 26% 41%
11/09 30% 29%
8/09 21% 43%

* The dividend payout ratio is the quarterly dividend divided by the quarterly actual earnings per share number. Sine May 2004, the dividend payout ratio has averaged 24% -- there is room for that to grow.

* Capital Returned is calculated on a 4-quarter trailing basis, with previous years being annualized over 4 quarters using 10-K data.

Costco could be buying back more stock, but the fact that it does not could also be a function of what management perceives to be more market opportunities for stores, hence its conservative free-cash-flow management.

Execution has been superb for COST, despite razor-thin store margins. Recently, Target (NYSE:TGT) and Wal-Mart (NYSE:WMT) reported weak U.S. numbers, some of it due to weather and some due to the payroll tax hike and delayed tax refunds.

COST's March and April comps do not reflect any slowing in its store traffic.

In general, when the majority of department stores reported two weeks ago, our SeekingAlpha preview thought the sector was fairly valued, and we haven't really changed our mind much since. Wal-Mart and Target, the low end of general merchandise retail, were weaker, but not horribly so.

No question COST is executing superbly.

Disclosure: I am long COST, WMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Tagged: , Discount, Variety Stores, , Earnings
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