Shares of Costco Wholesale Corporation COST have fallen almost 20% from its 52-week high, placing the stock on the doorstop of bear market territory.
Nothing has fundamentally changed about the company. Costco recently reported another quarter with impressive same-store sales. The company has been a consistent grower of both its top and bottom-lines over the last decade.
What the sell off in shares has done is reduced Costco's valuation as the stock now trades much more in-line with its five-year average valuation then it did just a few months ago.
Let's look closer at the company's most recent quarter and valuation to see why I believe that this could be an excellent opportunity for investors looking to start a position in the name.
Earnings highlights
Costco reported earnings results for its second quarter of fiscal year 2021 on March 4. Revenue grew 14.6% to $44.8 billion, which was $1.05 billion above what Wall Street analysts had expected. Adjusted earnings per share totaled $2.55, which was a 21.4% improvement from the prior year and 12 cents ahead of estimates.
Same-store sales grew 13% for the quarter (12.9% when excluding fluctuations in gasoline prices and foreign exchange). This was a slight slow down from the first quarter's same-store sales growth of 15.4%. Costco's adjusted same-store sales were strong in all regions, with the U.S. growing 12.6%, Canada higher by 10.6% and international up 17.7%. The U.S. growth rate fell 440 basis points while Canada was lower by 620 basis points. International was flat.
Food grew at a high single-digit percentage, with strength in the liquor, frozen foods and cooler categories. Bacon pounds sold were up 45%. Toys, seasonal, sporting goods and hardware also showed strength. Fresh food posted a 20% gain, led by meat and deli. Housewares, small appliances and home furnishings were all up at least 20%.
The slowdown in same-store growth rates may have led some investors to believe that pandemic related demand may be slowing. If so, I believe this to be shortsighted. Costco has a long history of growing sales at an impressive rate. Annual sales have increased with a compound annual growth rate of 7.9% over the last decade. This shows that Costco was popular amongst consumers long before the pandemic occurred.
The company's other sales metrics were very good as well. Traffic improved 1% worldwide year-over-year, but 2.7% in the U.S. The average ticket transaction was up 11.9% globally and 8.5% in the U.S. This was in the face of a 100 basis point headwind from gasoline price deflation.
Costco's stores offer everyday items, such as groceries and clothes, in bulk at near costs. This is appealing to consumers as the prices often beat the competition. The company also sells a wide variety of big-ticket items, such as furniture and televisions. The company makes the majority of earnings (approximately 75%) from its membership fees. Retention rates in the U.S. are above 90% and the company often raises the prices of these memberships every few years without seeing a major decline in membership numbers. Membership fees increased 7.9% and 7.5% for the quarter and first half of the fiscal year, respectively.
Membership fees continue to advance, partly due to higher club fees but also due to an increase in overall members. For example, 59.7 million households had a membership at the end of the first half of the year compared to 59.1 million in the first-quarter.
Second, Costco has invested heavily in its e-commerce capabilities over the past few years. The company now offers same-day delivery at many of its locations. As recently as 2018, e-commerce sales accounted for less than 5% of total sales.
While the company hasn't broken out what percentage e-commerce now contributes to the total, it is safe to this channel now accounts for a more meaningful amount of revenue. E-commerce sales were higher by 75.8% for the second-quarter. This is down from 86.4% sequentially, which may give fuel to the belief that growth is slowing, but digging deeper we see that e-commerce actually accelerated and grew 91.1% for February. And this is compared to the previous year, which saw a substantial uptick in online sales ahead of the pandemic.
Leadership mentioned that grocery, over-the-counter and pharmacy, health and beauty, garden and patio and consumer electronics all saw meaningful gains. As more consumers become comfortable ordering groceries and other items through e-commerce channels, it is likely that they will be continue to do so. The integration of logistic company Innovel, which was bought for $1 billion in cash and renamed Costco Logistics, is another step on the path to continued outperformance in the area of e-commerce.
Costco is also experimenting with curbside pickup, another shopping characteristic that came to be due to the pandemic and is likely to stay. The company has three warehouse curbside pickup locations in Albuquerque, NM. The company is still in the initial test phase of this program, but early results have been promising as basket size have been higher than expected.
The company's balance sheet is in good shape as well. As of the quarter's end, Costco had total assets of $54.9 billion, including current assets of $26.3 billion and cash and equivalents of $8.6 billion. Inventory of $13.9 billion was 13.3% higher than the first-quarter, but this isn't that worrisome considering the growth rates Costco has experienced recently.
Total liabilities stood at $38.8 billion, with current liabilities of $26.6 billion. Total debt was $7.6 billion, but just $95 million of debt obligations mature within the next year.
Costco didn't provide guidance for the fiscal year on the conference call, but analysts expect that the company will earn $9.95 in fiscal 2021. If achieved, this would be a 10.3% increase from the prior fiscal year, which is nearly identical to the CAGR over the last decade.
This high level of earnings growth has enabled the company to grow its dividend for 17 consecutive years. The dividend has been raised at a low double-digit clip over the last 10 years. Costco also has a habit of distributing a sizeable special dividend every few years, the most recent of which a $10 dollar special dividend that was paid to shareholders on Dec. 11, 2020.
Valuation
Costco closed Monday's trading session at $311.42. Using expected earnings per share for the fiscal year, the stock has a forward price-earnings ratio of 31.3. For context, Costco has a five and 10-year average price-earnings ratio of 29.5 and 26.7, respectively. Shares trade at a premium to both averages, but not a significant one, in my opinion.
GuruFocus has found Costco to be trading well above its intrinsic value for some time, but that has changed as the share price has retreated.
Costco has a GF Value of $320.73 according to GuruFocus, which gives the stock a current price-to-GF Value ratio of 0.97 and earns the name a rating of fairly valued.
Final thoughts
Costco once again showed double-digit comparable sales growth in all of its markets. Though this was a sequential decline in most regions, it is still evidence that the consumer is flocking to the company's stores. Some of this surely is related to the ongoing pandemic, but visit and ticket size increases show that the consumer is willing to spend at stores.
The company also has several factors going in its favor aside from pandemic spending. Food and goods are often cheaper on a unit basis at the stores, and Costco's investment in e-commerce is paying off. Costco also has a long track record of growing its sales, earnings per share and dividends, all of which should be attractive features for investors.
Costco isn't cheap by either a comparison to its prior valuation averages or its intrinsic value according to GuruFocus, but the stock is rarely on even this much of a sale. Investors looking to initiate a position in Costco might find the decline from the 52-week high a good spot to purchase shares of the company.
Author disclosure: the author maintains a long position in Costco.
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