Costco: A Retail Stock To Buy As Consumers Shift To Discount Retailers

Oct.10.12 | About: Costco Wholesale (COST)

Costco (NASDAQ:COST), a chain of membership warehouses, has been benefiting from the economic situation, much like other discount chains; Target (NYSE:TGT) being one example. It has seen a lot of upgrades recently and is trading at almost its 52-week high value, after the 4.5% move due to its earnings release. We have a buy rating for this stock, as there is still some upside left, as customers are driven towards discount chains because of economic worries. The earnings are expected to continue to increase by 13% in the next five years.

Q4 2012 performance:

Q4 net sales were up 14% YoY to $31.52 billion. Analysts were expecting $31.69 billion on average. Full year sales were up 12% compared to last year's increase of 14%. Revenue from membership fees advanced 17.6% in Q4. Foreign exchange had a significant effect on international comparable store sales. They increased 7% excluding foreign exchange impact and only 2% including it in Q4. Overall, including foreign exchange impact, the company's comparable sales were up 5% (U.S. were up 6%).

The company's Q4 EPS beat analyst estimates, like it did for all the quarters of this fiscal year. The company posted $1.39/diluted share compared to analyst estimates of $1.31/diluted share and last year's EPS of $1.08/diluted share. For the full year 2012, EPS rose 18% YoY compared to 13% increase in 2011.

The operating margin for Q4 increased by 0.2%, from 2.7% in Q4 2011 to 2.9% in Q4 2012. For the whole year, it increased from 2.7% to 2.78%. The five-year average for operating margin is 2.63%. The net profit margin for the full fiscal year 2012 is 1.72% compared to the five year average of 1.69%. This improvement can be attributed to keeping prices low to get more traffic, to adding more services and selling more private label items according to a Bloomberg Businessweek article.

The latest September same store sales increase of 6%, on top of 7% increase in September last year, show that the company's offerings are resonating well with the customers when spending is facing pressure due to economic uncertainty. Analysts were expecting a 4.5% increase for September same store sales. Coupled with a 6% increase in August same store sales this year, it reflects that the company enjoyed a healthy back to school season, which is the second-most fruitful season for retailers after the holiday season.

Recent price targets and rating reiterations:

Piper Jaffray analysts reiterated their overweight rating for the stock with a price target of $112. JP Morgan Chase had earlier reiterated their overweight rating in September with a price target of $101. BofA Merrill increased its price target to $110 from $98, citing strong fall expectations and new store growth, along with strong same store sales.

Valuation:

The company's earnings are expected to grow almost 13% in the next five years, while the past five year growth rate was around 6%.

The company has a forward P/E of 23x, which is the same as its five year average P/E. It is trading at a premium compared to peers like Target and Wal-Mart (NYSE:WMT) with forward P/E of 13x and 14x, respectively. Below are COST's valuations, at forward P/E multiple of 23x.

*2014 EPS is calculated by applying the 13% growth rate on 2013 EPS.

We think that there is still some upside left as the company continues to remain in favor in present economic conditions. The company has healthy financials and a modest dividend yield of 1.1%.

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

Business relationship disclosure: The article has been written by Qineqt's Retail Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.