Costco - Earnings Miss And Premium Valuation Leave No Value To Be Found

Dec.12.13 | About: Costco Wholesale (COST)

Investors in Costco Wholesale (NASDAQ:COST) are not happy with the retailer's first quarter results for the fiscal year of 2014. After shares have witnessed very strong momentum in recent years, which has resulted in premium valuation multiples, expectations have risen.

The miss on both revenues and earnings is noticeable, and could be the start of a further correction.

First Quarter Results

Costco Wholesale generated first quarter revenues of $25.02 billion, up 5.5% on the year before. Consensus estimates for revenues stood at $25.35 billion.

Net earnings growth trailed revenue growth with earnings increasing by a modest 2.2% to $425 million. Diluted earnings per share inched up by a penny to $0.96 per share. Consensus estimates for first quarter earnings stood at $1.02 per share.

Looking Into The Results

Costco's revenue growth is driven by the 5.5% increase in "normal" sales to $24.47 billion. The lucrative membership fees increased by 7.4% to $549 million.

Reported comparable sales growth came in at 3% for the US activities and the overall company, while international comparable sales rose by a percent. Adjusting for gasoline price deflation and currency impacts, which had quite a negative impact on reported sales growth, comparable sales were up by 4% in the US, 6% for the international activities, and 5% overall.

Gross margins saw a modest boost, increasing by 13 basis points to 10.8% of total merchandise revenues. Selling, general and administrative costs increased by 17 basis points to 10.0% of total sales.

As a result, operating earnings in relation to total revenues were down by 2 basis points to 2.67%. This just once more highlights the low margin business in which Costco operates. Slightly higher interest expenses limited the net earnings growth severely.

Valuation

Costco ended its first quarter with $6.4 billion in cash, equivalents and short-term investments. Total debt stands at $5.0 billion, for a solid net cash position of $1.4 billion.

Revenues for the fiscal year of 2013 came in at $105.2 billion, up 6.1% on the year before. Net earnings rose by 19.3% that year to $2.04 billion.

Trading around $117 per share, the market values Costco at $51.5 billion. This values operating assets of the firm at $50 billion, the equivalent of 0.5 times annual revenues and 25 times annual earnings.

Costco currently pays a quarterly dividend of $0.31 per share, for an annual dividend yield of 1.0%.

Some Historical Perspective

Long-term holders in Costco have seen solid returns. Between 2003 and 2007 shares doubled to highs of $70 per share. Shares nearly halved again towards 2009 but ever since have seen a very steady but impressive run-up towards $120 per share.

So far this year, shares have already risen another 20%, trading as high as $126 per share in November.

Between 2010 and 2013, Costco has increased its annual revenues by a cumulative 35% to $105.2 billion. Earnings rose by nearly 60% in the meantime to little above $2.0 billion.

Valuation

The first quarter earnings report for the fiscal year of 2014, appears a bit soft. Even when adjusting for gasoline deflation and unfavorable exchange rates, comparable store sales growth of 5% is slowing down from previous quarters.

Note that this is still impressive in the light of comparable store sales growth reported by large competitors like Wal-Mart (NYSE:WMT) and Target (NYSE:TGT), which reported a 0.3% fall in comparable sales and a 0.9% growth, respectively. Also be aware that "Black Friday" sales were include in last year's results, but not in the first quarter results of this year.

Note that Costco is still heavily focused on the US, even as it marks further expansion, notably abroad. The company operates 648 warehouses worldwide, each generating sales of $38.5 million per quarter on average, just indicating how productive these stores really are.

Back in May of this year, I last took a look at the prospects for Costco, with shares trading around $110 per share at the time. I concluded that there was more value to be found in the stores, rather than in the shares.

The competitive pricing has driven a lot of traffic towards Costco's stores, while the membership fees boost earnings. As such, Costco continues to gain terrain versus its main competitors, largely on the back of increased traffic.

While cumulative revenue and earnings growth over the past years has been impressive, the share price returns have outpaced the operational improvements. Shares tripled between 2009 and today, far outpacing earnings growth which has boosted the valuation towards 25 times earnings. This is a bit steep with flat earnings growth at the moment.

While the company has a great track record, treats its associates well, and sees further expansion through store openings, I remain cautious. The current valuation is too much based on momentum, and I remain cautious, staying on the sidelines.

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.