Costco Stock: Swell Company But No Bargain for Investors

Costco Wholesale (NASDAQ: COST) reported third-quarter earnings on Thursday, and while the numbers are certainly encouraging as far as Costco still being a great company, they do not give investors too many reasons to buy in at these levels.
Costco missed on the top line by $1.09 billion, with sales of $25.52 billion versus $25.33 billion last year, an unimpressive 1% increase. EPS came in at $1.17 per share, an increase of 10% from $1.07 year over year.
Most investors, however, seem concerned over the effect of lower gas prices and the strong dollar on sales. Retailers across the board are struggling with the latter, but the former is an important contributor to profit for Costco.
These effects show up in the same store sales metric. Remember, we want to get a snapshot of how a company’s current stores are performing from an organic growth perspective, without new stores muddying the reporting.
U.S. same-store sales only rose 1% for Q3, and a so-so 4% for the first 36 weeks of the year. On the international side, same-store sales dropped 6% for the quarter and fell 2% for the year. When we combine these metrics, same-store sales declined 1% for the quarter and increased 2% for the year.
Here, however, is where the dramatic effects of gas and foreign exchange whacked Costco. If we back out these effects, U.S. comps increased 5% for the quarter, and 7% for year so far. Internationally, the quarter and 36-week period increased a very impressive 7%. On a combined basis, that put a 6% increase on comps for the quarter and 7% for the year.

Watch the Membership Fees

I like to keep an eye on membership fee revenue, because while it only makes up a tiny part of the company’s overall sales, it is basically free money for the company. In fact, because margins are essentially 100% on those fees, they account for virtually of the company’s net income.
That’s right – if Costco didn’t have their membership fees, they would be out of business. In case you don’t believe me, membership fees increased from $561 million to $584 million, and net income for the quarter was $516 million (up from $479 million last year).

Seize the Kirkland Brand

There’s another interesting thing going on at Costco. Net income was up about 6%, but merchandise costs only rose a little bit. That tells me that Costco’s private-label brand, Kirkland, is seeing increasing popularity.
I personally think the Kirkland brand is outstanding. I’ve never had a product from the private label that didn’t perform, including the food. That’s also higher margin sales for the company, and customers seem to realize that the private label is just as good as the brands.
Alas, Costco stock is also popular among investors, and that’s why it is selling at an outrageous price. FY15 earnings estimates are for $5.24, which is a very solid increase of 13% from FY14. However, Costco stock trades at 26x FY15 earnings! That’s just crazy. I’m not going to pay a PEG ratio of 2.0 on a stock unless it is a growth stock, showing at least 17% organic EPS growth
Neither should you.

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