Costco has been the best single holding in my portfolio and after 10 years and ~1000% gains, I liquidated my holdings of Costco when it crossed $900 last week. To be clear, Costco is going to have a fantastic report today – we know this because they already release monthly sales and Costco has continued its industry leading performance, and the limited revenue growth projections of 1% are largely due to the fact that the comparable YoY quarter is a week shorter. Moreover, on an annual basis, Costco is probably one of the only companies out there that hasn't had a single losing year over the last decade. I'm also a huge Costco shopper that continues to be an addict in throwing more spend in, despite my perception that many of Costco's core staples aren't as good of a deal as they used to be.
Revenue has improved 5%+ every year. More impressively, so has net margin, improving 50% from ~2% to 3% over the same time period. I believe the bull case that both of these trends will continue at very little risk. Costco has an amazing team to select locations and proof of international scale. It also has room to continue to steadily improve margins through its supply chain, pricing, product mix, membership price increases, and eCommerce penetration.
But what used to be a bull case for this stock has now become bull fantasy. The arguments for Costco popping to $1000 boil down to:
1) Costco stock has always been expensive and PE doesn't matter
2) Stock split = $$$
3) My local Costco has long lines
Yes, Costco stock has always commanded a premium above industry. And every single quarter, every Costco bear that has said “Costco stock is too expensive” has been slapped in the face and proven wrong. Personally, I think Costco deserves tech-stock like valuations and a multiple of the rest of the industry. This year has been different. Costco PE ratio has eclipsed Nvidia, and is now above 55; Costco is now more expensive than it's ever been relative to its earnings by an enormous margin. For reference, if Costco instantly doubled in size right now and paid out 100% of its profits in dividends in perpetuity, it's yield would still be a little smaller than the 10Y treasury.
A PE ratio above 50 means quite simply that you are investing in the company because you are confident earnings will explosively grow in the next few years. I am betting Costco is going to continue to be Costco – an amazingly well run company that takes almost no risk in continuing to improve over time, resulting in fantastic high single digit eps growth. The bull case now is essentially betting that Costco isn't going to be Costco, but rather something entirely different in 5 years. Those betting on Costco eclipsing $1000 after earnings today are betting that Costco will have an unprecedented pop on the quarterly report (there has never been a +10% before) and a 60+ TTM PE ratio. At some point, optimistic becomes insanity and we're there already.
And there are downside factors to consider too. If revenue has already been largely reported, the report really centers around margin and comments on future growth.
-
5-10% of Costco's growth has been from gold bars, which will likely be dilutive to margin (2% margin on these vs a typical 10-15%)
-
Gas prices going down isn't good for Costco
-
As Costco expands it membership base, share of wallet, and portfolio of products, it becomes increasingly tied to US macroeconomic conditions simply as a function of being a more meaningful representation of total consumer spend
-
Membership price increases were smaller than some desired and haven't fully taken effect
-
Costco door scanners were likely implemented after tests proved they were accretive in the short run for margin due to improved shrinkage and folks buying more memberships; but this isn't like Netflix where each membership increase is just pure margin – the story on basket sizes, renewal impacts, and potential competitive dynamics is likely a little more murky, and will take longer to play out given annual vs. monthly renewals
-
Costco lines consistently being long everywhere quarter after quarter might be a hindrance and capacity constraint vs not
-
eCommerce margins are still unclear along with the impact of Instacart on memberships
Leave a Reply