The Costco Juggernaut: Forward Revenue Estimates Have Increased; EPS, Less So

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Includes: COST
by: Brian Gilmartin, CFA

Summary

Forward revenue estimates have increased, EPS less so.

Free-cash-flow yield now between 5% - 6%.

Costco's valuation at high end of relative range.

Costco (COST), the warehouse club giant that has dominated the space, reports its fiscal Q1 '18 financial results after the closing bell on Thursday, December 14, 2017.

Analyst consensus is expecting $1.34 in earnings per share (EPS) on $31.43 billion in revenue for expected year-over-year growth of 8% in earnings per share and 12% in revenue growth.

Costco had its first decent correction in the stock price this past year, trading down from the low $180's to the low $150's from June '17 through early August '17, although the stock is once again trading close to an all-time-high pre first quarter '18 financial results.

Here is a quick look at revenue and EPS estimates for COST:

Q1 '18 (est) Q4 '17 actual Q3 '17 actual Q2 '17 actual
2020 EPS est $7.61 $7.60 $7.72 $7.86
2019 EPS est $7.07 $7.04 $7.10 $7.13
2018 EPS est $6.45 $6.43 $6.41 $6.43
2020 est EPS gro rt 8% 8% 9% 10%
2019 est EPS gro rt 10% 9% 11% 11%
2018 est EPS gro rt 10% 9% 12% 13%
2020 P.E 24x 20x 23x 22x
2019 P.E 26x 22x 25x 24x
2018 P.E 29x 24x 28x 26x
2020 rev est ($bl's) $155.2 $153.3 $153.3 $151.4
2019 rev est $146.6 $143.5 $143.7 $143.0
2018 rev est $137.5 $134.9 $134.9 $134.2
2020 est rev gro rt 6% 7% 7% 6%
2019 est rev gro rt 7% 6% 6% 6%
2018 est rev gro rt 7% 5% 6% 6%

Source: Estimates from Thomson Reuters I/B/E/S as of 12/10/17

COST Cash-Flow and Free-Cash-Flow history:

CFFO y/y gro capex y/y gro FCF y/y gro FCF yield
fiscal '17 $6.7 bl 94% $2.5 -6% $4.2 +430% 5%
fiscal '16 $3.5 bl 19% $2.7 +12% $0.800 -58% 1%
fiscal '15 $4.3 bl 8% $2.5 +20% $1.9 -5% 3%
fiscal '14 $3.99 16% $2.1 -4% $2.0 +47% 4%
fiscal '13 $3.4 7% $2.0 +61% $1.3 bl -29% 3%

Source: internal spreadsheet (the height of geekdom)

Readers can see COST has a nice bump in their cash-flow and free-cash-flow the last 12 months, just as the worries about Amazon (NASDAQ:AMZN) and Whole Foods have reached fever pitch.

COST has declared three special dividends in their history, the most recent of which was paid in May, 2017. The other two were paid in December, 2012, and May of 2015.

It would be unusual to see COST pay another special dividend so soon, but they have the cash as it stands now.

Cost Valuation:

Metric
3-yr avg EPS gro rt 9%
3-yr avg rev gro rt 7%
3-yr avg P.E 27x
Price-to-sales 0.53x
Price-to-book 6x
Price-to-cash-flow 10x
Price to Free-cash-flow (FCF) 16x
Dividend yield 1.2%
Free-cash-flow yield 5% - 6%
Div as % of FCF 30% (normalized)
ROIC 22%
Morningstar fair value estimate $163
moat rating wide
Finboxio fair value estimate $172

Source: internal valuations spreadsheet

Analysis / conclusion:

One of the reasons to show forward consensus revenue and EPS expectations for a company is to study both the absolute revisions to the estimates (up or down, and by how much) or relative changes in the estimates i.e. how fast or slow revenue is increasing compared to EPS, etc.

Josh Arnold's Costco preview I thought struck the right chord on COST and I wanted to show the numbers to readers to confirm Josh's thoughts on COST margins.

While COST's margins are thin as it is, it was worries about renewal rates for COST that send the stock down from $175 to $150 this summer.

Here is a quick table on the operating and net margin for COST:

Operating mgn Net mgn
1-yr 3.16% 2.07%
3-yr 3.12% 2.02%
5-yr 3.02% 1.96%

Source: internal spreadsheet, with a simple average taken for 4, 12 and 20 quarters

The trend shows margins actually improving slightly over a few time frames, but the risk in COST's business is that those margins are razor thin to begin with.

While Amazon - Whole Foods was perceived as an immediate competitive threat to COST and other big box retail, the fact is Amazon is playing a very long game.

COST's ecommerce revenue is still just 4% - 5% of total revenue, and it has nowhere to go but up. But compare COST's competitive response to the speed with which Wal-Mart (NYSE:WMT) moved to put them on a somewhat even paying field with Amazon, if you can call it that.

Simply put - and this could very well be an erroneous assumption on my part - but I just don't know how this business doesn't get more competitive from a margin standpoint over the next 3 - 5 years. Amazon will learn how to function within a bricks-and-mortar environment, and COST annual members will look at that annual fee versus the annual cost for Prime.

For Thursday's earnings report, based on how other big box retail is trading, the stock could be up $5 given the strong November comp's and the upward revisions to revenue estimates. The food deflation that has been the big worry over the last 4 - 8 quarters seems to be gone, and that will help COST pricing.

One client has one long-term position in COST of $41 per share from 2005, and that is the entire position held amongst all client accounts.

Finally, given COST's valuation, there are better alternatives - like financials - where a portfolio manager can find mid-to-high-single-digit EPS and revenue growth without paying a lofty multiple.

And just to be clear to readers, I'm a Costco card member, and I enjoy shopping at the Lincoln Park, Chicago, several times a year. Hopefully this note won't get me run over in the parking lot, when they are wheeling the carts around.

Jim Sinegal founded a world-class retailer, and it's a first-rate operator but the valuation and the thin margins. This is not to mention the Amazon competition that will only increase over the years has kept me out of the stock, and will likely do so for a very long time.

Here is an article on COST's capital return policy from September, 2015 that looks pretty good in hindsight - except for not loading up on the stock when it was trading near $150.

If cash flow keeps growing the way it has we might see another special dividend sooner rather than later.

Disclosure: I am/we are long COST.

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.