America’s favorite wholesaler, Costco Wholesale Corp. (COST, Financial), is heating up.
While Costco’s growth story isn’t explosive, we see the retailer’s recent growth and progress as a sign of positive, steady movement upward. As the company continues to expand locations nationwide, we expect to see even further revenue and income growth.
With grocery retailers, the key is the consumer. Right now in summer of 2018, the consumer economy is in very solid shape. Consumer spending is at an all-time high and consumer confidence has steadily increased over the last seven or eight years. Barring any disaster – which our current political climate might engender – Costco should operate within healthy economic conditions.
Although there are no fireworks or theatrics with this one, we see Costco as a solid value buy for our readers interested in a long-term hold.
Chugging along
Costco’s growth story is solid, if not glowingly impressive. Growth has been tepid some years, and significant in others. All in all, the company continues on an upward trajectory, coming out of rough economic times stronger and emboldened for the future.
Revenue growth has been sufficient to support our call for a long-term hold. While total revenue increased by a fairly unimpressive 2% from 2015 to 2016, this past year, revenue increased an impressive 9%, a solid increase that brought gross profit above $16 billion (in fact, it is $17.1 billion) for the first time in Costco’s history. If the company can maintain growth between 2% and 9%, preferably in the 5% to 9% range, the stock will reflect that upward change.
Further, costs are not dramatically outpacing revenue growth, which is allowing for steady, although not significant, income growth. Total earnings, or net income, actually fell very slightly from 2015 to 2016 (less than 1%), but recovered in 2017, moving to $2.7 billion, a 14% increase. 2017 was a particularly strong year financially for Costco.
Clearer road ahead?
The hope for the company will be to continue to grow, perhaps even expand rapidly, as demand for wholesale retail increases across the United States, while keeping costs as low as possible. Cost of revenue, non-recurring expenses, selling, general and administrative costs, interest and income tax expenses have all either held steady with revenue growth or been lower, allowing, in particular, for the significant net income growth over the last year.
Earnings are an area of somewhat minor concern. Yes, 2017 was a strong year for earnings, but the company has a mixed track record and the verdict is still out as to whether Costco can stay near or above the 10% income growth mark for the foreseeable future, or fall victim to tepid growth like we saw the year before. We believe it is likely to be the former.
What kind of growth to expect?
The question of growth is maybe the most important for Costco. Yes, current stores are performing well, as are newer stores. Returning customer revenue continues on an upward trajectory. In addition, consumer demand is significant.
Costco’s expansion plan moving forward will be key to keeping growth numbers up. The company plans a significant expansion both domestically and internationally. Costco now has set up shop in 10 countries and more than 200 international locations. That brings Costco’s global total to 741 warehouses as of the end of 2017. Imagine what the company would be raking in with 1,500.
Our view is growth will likely be moderate in the short term, but that Costco should continue its plan to intelligently and leanly expand both domestically and internationally.
Castle and moat
Costco has been called a castle with a moat by more than a few commentators in the past. It’s a favorite metaphor we like for the wholesaler. It means that Costco is a unique type of retail grocer with its own type of business model, namely having members who pay yearly fees to gain access to low prices when they buy in bulk. This makes them different from, say, a Safeway, Jewel Osco or Kroger (KR, Financial).
This also gives them certain advantages. While consumers might cut back on purchases from traditional grocers, they are unlikely to cut back as much from Costco given the savings they get to enjoy. Costco does not become nearly as much of an undue burden during rough economic times.
Now, this certainly does not mean Costco can’t face economic pressure. The company felt the effects of the 2008-09 financial crisis acutely, but managed to stay afloat and continue growth. The "moat" of its membership base, unique model and low prices, however, will likely help keep the retailer healthy in the long run.
As with all retailers, challenges include consumer spending, rising costs and marketing. Again, however, Costco has the advantage of being the country’s largest wholesale food provider, and it faces some limited competition. Amazon (AMZN) and other bulk shopping sites could cause future trouble, but, for now, Costco looks poised to continue being the king of its hill.
Verdict
Costco is a solid company with a strong brand, loyal customer base and quality, affordable products. What more could you want?
While the company won’t be experiencing explosive or wild growth in the next several years, this stock isn’t one for our readers looking for a quick growth play. But it will no doubt reap rewards as Costco continues to expand, grow and benefit from a healthy consumer environment. And it can do so even if the market turns sour, making it a potentially appealing conservative play in these choppy market waters.
It might be well worth investors’ time to make a bet on America’s favorite wholesaler.
Disclosure: I/We own no stocks discussed in this article.
(This article was co-authored by Clyde William Engle Jr., an investment analyst with Almington Capital – Merchant Bankers.)
