In several earlier articles (see here and here), I have emphasized how even Wal-Mart (WMT) is facing price competition. Significant macro headwinds are only the making the situation worse with customers concerned about jobs, and 1 in 10 mom shoppers expressing fears about the economy. Not coincidentally, Costco (COST) has seen weak margins, but has taken an opposite approach by raising membership fees.
From a multiples perspective, Costco is the more expensive of the two. It trades at a respective 25x and 18.7x past and forward earnings with gross margins of 12.6%. Wal-Mart trades at a respective 13.1x and 11.9x past and forward earnings with gross margins of 25.3%. Analysts currently rate shares of both companies a "buy," but give preference to the largest retailer. From a strong brand name to stellar management and fundamentals, Wal-Mart ultimately has little downside.
Costco similarly has a timeless brand, but challenging compares is limiting top-line movement. At the first quarter earnings call, Costco's CFO, Richard Galanti, placed the situation in a more rosy context:
In terms of sales for the first quarter as was reported in the press release, our 12-week reported comp sales figures for Q1 showed a 10% increase, 10% in the U.S. and 11% internationally. Excluding gas price inflation and the impact of FX, the 10% reported U.S. comp would be fixed and the 11% reported international comp and local currency would be at 10%. And for the company overall, excluding both of those, the 10% reported number would be at plus 7%.
Other topics of interest of review, our opening activities and plans, we opened 4 new locations during the first fiscal quarter of 2012 which ended November 20, one each in Pennsylvania, Texas, Wisconsin and Georgia. For all of fiscal 2012, our current plan of 20 net new locations, 11 of which will be in the U.S., one each in Canada and the U.K.; and 7 in Asia, 3 in Korea and 4 in Japan. This week, we -- in fact, of the 4 in Japan, this week we will open 2 of these new Japan units. And with these openings, we'll end the calendar year and this week with 598 locations around the world.
I wish the expansion effort was more focused in the emerging markets, but a faster-than-expected recovery in developed markets will help to drive higher risk-adjusted returns. Although sales roughly met expectations, gross margins for core merchandise ex-gas fell by 10 basis points - the first time it dropped in two years. Same store sales grew by 10% for the first quarter and, going forward, ROIC is still likely to expand by ~600 basis points to ~23.3% in 2012 while SG&A increases in leverage.
Consensus estimates for Costco's EPS are that it will grow by 11.8% to $3.69 in 2012 and then by 19.2% and 17.7% more in the following two years. Of the 13 revisions to EPS, all but one went down. Assuming a multiple of 20x and 2013 EPS of $4.30, the firm has 4.2% upside. If the multiple were to plummet to 18x and 2013 EPS turns out to be 5.7% below the consensus at $4.15, the stock would fall by only 9.5%. Accordingly, although I believe the company has less downside than the Street acknowledges, upside is limited enough that I recommend holding out.
Wal-Mart had relatively strong results with operating income growth exceeding sales growth. In addition, eCommerce activity resulted in greater purchases per store. The firm's new workflow program has increased productivity, and I am optimistic that its expansion in emerging markets will help to expand margins and provide sustainable cash flow.
Consensus estimates for the leading retailer's EPS are that it will grow by 10.3% to $4.40 in 2012 and then by 9.4% and 10.4% more in the following two years. Assuming a multiple of 15x and a conservative 2012 EPS of $4.86, the firm has 25.1% upside.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
