Costco: Expansion The Difference Maker

| About: Costco Wholesale (COST)

With annual revenues of almost $103 billion, Costco Wholesale Corp. (NASDAQ:COST) is the largest wholesale club operator in the U.S. The company has delivered a healthy financial performance in the past. COST has been aggressively working to increase its stores in the U.S. and international markets, which will help the company improve margins, increase its market share and grow its earnings. Also, current valuations (forward P/E of 20x) look attractive in comparison to its own historical valuations, and the stock offers a potential price appreciation of 10% based on my price target of $127 (as shown below). Therefore, I recommend a "buy" rating on the stock.

Last week, COST reported a satisfactory financial performance for 4Q FY2013. The company reported net sales of $31.77 billion for 4Q FY2013, as compared to $31.54 for the corresponding period last year. Adjusted net sales for the quarter were up 6.7% year-on-year. COST was able to expand its comparable store sales for the quarter by 5%, mainly driven by an increase in frequency, which had a positive impact of 4.5% on comparable sales for the quarter. Adjusting for the extra week in 4Q FY2012, COST's online sales for 4Q FY2013 increased by approximately 15%.

Profits for the company were up slightly, as it reported an EPS of $1.40 for the quarter, up from $1.39 in 4Q FY2012, missing consensus estimates of $1.46. The earnings miss for the quarter was mainly attributed to a 1.77% increase in selling, general and administration expenses. Interest expense for the quarter amounted to $36 million, representing an increase of $14 million year-on-year, which had an inverse impact on the bottom line of the company. Interest expense for the quarter increased mainly due to a $3.5 billion debt offering that was undertaken in relation to the $7 per share of special dividend.

COST is the largest operator of wholesale stores in the U.S. The company has been doing well in expanding its stores, which has helped it maintain its dominant position in the industry. By the end of FY2013, the company had 634 operational warehouses, including 451 in the U.S. COST continues to expand its stores to increase its revenues and market share. It plans to open 36 new stores in the ongoing fiscal year, 2014, representing an increase of almost 5% in square footage. The planned 36 new warehouse stores that the company plans to open in fiscal year 2014 include the U.S and international markets. As the company continues to expand its warehouse stores, it will help the company grow its revenues and improve upon its returns.

Currently, COST has 638 operational warehouses, out of which nearly 30% are in markets other than the U.S. International markets also provide growth opportunities to the company, and COST has been working to tap available growth opportunities. COST plans to open 18 warehouses in fiscal year 2014 in international markets. As the company will continue to focus more on international markets, international growth will help the company improve returns and margins.

Dividend and Share Repurchases
The company has a shareholder-friendly management team. Currently, the company offers a dividend yield of 1.10%. COST has increased its regular quarterly dividend from $0.115 per share in 2006 to $0.31 in 2013. In the last fiscal year (2013), the company also paid a special dividend of $7 per share or $3 billion in total. Also, the company has been undertaking a share repurchase program to share its success with shareholders, which will also help the company grow its bottom line. In fiscal year 2013, COST repurchased $35 million worth of common stock.

COST is the leading wholesale club operator in the U.S. and is best positioned in the industry to improve same store sales and expand its market share. COST is also doing well by opening new stores in the U.S. and in international markets, which is likely to increase its market share, expand margins and fuel earnings growth. Moreover, analysts have estimated an attractive next five years growth rate of 13.6% per annum.

Furthermore, current valuations also look attractive for COST. The stock is currently trading at a forward P/E of 20x, in comparison to its historical three years average P/E of 23x. Using the historical three years average of 23x and next fiscal year (2015)'s EPS estimate of $5.5, I calculated a price target of $127. Based on my price target of $127, the stock offers a potential price appreciation of 10%. Therefore, I recommend a 'buy' rating on the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.