Costco Defies the Odds

Costco Wholesale (NYSE: COST) once again bucked the trends and defied the odds in brick and mortar retail by growing. The club store giant’s revenues grew by nearly $4 billion ($3.92 billion) between February 2016 and February 2017.

Costco reported $117.27 billion in revenue at the end of February 2016, and $121.19 billion a year later. That’s a very impressive achievement in a very difficult retail environment.

During the same period Target (NYSE: TGT) saw its revenues shrink by $4.28 billion. Target reported $73.78 billion in revenues in January 2016 and $69.50 billion a year later.

Rick Bowmer/The Associated PressCustomers shop at a Costco in Portland on Dec. 7. Wholesale companies increased their stockpiles in October by the most in five months, a sign they expect consumer demand to rise.

What is Costco Doing Right?

This raises the interesting question what is Costco doing right that Target is doing wrong. One key to success might be Costco’s memberships which encourage loyalty and bulk buying.

Another is Costco’s appeal to upper income customers, one of the fastest growing segments of today’s market. The Pew Income Study found that the percentage of Americans in the highest income brackets grew from 7% in 2001 to 8% in 2011 to 9% in 2011. Pew also found that 21% of Americans could be described as rich or upper-middle class in 2016.

It is also obvious that Costco has a very resilient business model, it obviously easily survived the debacle of the switch to the new Citi Bank Visa card from American Express (NYSE: AXP) last year. The convenience and good shopping experience seems to outweigh the annoyance of poor credit-card customer service.

Is Costco Amazon Proof?

This also raises the question: is Costco Amazon proof? Maybe, Costco’s business model does provide something of a moat against online retailers.

Unlike Target, and department stores, which have been suffering, Costco is not that dependent on fashion. It is not stocking large amounts of name-brand apparel which Amazon (NASDAQ: AMZN) can undercut its prices on easily.

Part of the reason for this is that Costco’s customers, many of whom are upper-middle class businesspeople are not that interested in fashion. They just want quality clothes at a decent price which Costco can easily provide. Such people don’t like wasting time with bargain hunting or shopping which discourages Amazon use.

Amazon has been trying to appeal to them through Prime, even launching its own casual clothing line. Yet the revenues show that Amazon has not figured out how to crack the Costco code yet. Therefore yes, Costco is Amazon proof and will remain so for the foreseeable future.

Is Costco Making Money?

Costco has one thing in common with Amazon, it is a very cash rich company. On February 28, 2017 it reported $4.976 billion in cash from operations, $2.384 billion in in net income and $5.965 billion in cash and short-term investments. This was in spite of a free cash flow of -$23 million and a profit margin of 1.73%.

So Costco is still making a lot of money and generating a lot of float. It is still a value investment, although one has to wonder how long that can continue.

My guess is that Costco’s moat is fairly safe for the next 10 years or so, making it a pretty good long term retail investment. Unlike dollar and department stores, Costco operates in a retail segment that’s fairly stable. It also serves a growing market segment unlike Target;which is struggling to serve a shrinking middle class.

The best prediction is that Costco’s business model will remain safe and stable for the next 10 years barring some sort of black swan event. That makes it rather unusual in an increasingly volatile retail environment.

Is Costco Overpriced?

As a stock Costco certainly has some attractive features including a return on equity of 20.20% on February 28, 2017. It also paid a dividend of 45¢ a share on February 8, that translated into a dividend yield of 1.07% on March 17, 2017.

Yet I think COST is overpriced at the $16166.89 a share it was trading at on March 24, 2017. Even though Costco is a great company there’s nothing in its financial report to justify those numbers.

My take is that Costco’s price is based on the fact that investors simply like the company and the stock. That should scare you off because such emotional attachments to a stock can change quickly. All it would take is one scandal; or a couple of quarters of lousy earnings reports to change that.

So yes, Costco is a very good stock, but I would wait until the price comes down to around $130 a share to buy it. The company is simply overpriced, even though it is still one of greatest success stories in retail.