Costco Is Better Than Its Rivals, But Still Looks Expensive Here

Stock Market

Costco (NASDAQ:COST) has been one of the best brick-and-mortar operators over the past two years. The retailer ran its stores impeccably during the pandemic. Amid a period of unprecedented supply chain disruption and labor force uncertainty, Costco has run a tight ship. This has allowed it to post an impressive string of double-digit top-line sales growth figures. That, in turn, has led COST stock considerably higher.

However, 2022 is looking a lot rougher for the retail industry. Soaring interest rates and gas prices are reducing disposable income. Meanwhile, the University of Michigan consumer confidence survey just plunged to a record low reading. This could bode ill for the all-important holiday shopping season this winter.

We’re already seeing many of Costco’s peers struggle amid the rapidly changing industry conditions.

Target and Walmart Set a Terrible Tone

Heading into Costco’s Q3 earnings release, there was every reason to be worried. Just prior to Costco’s own earnings announcement, both Walmart (NYSE:WMT) and Target (NYSE:TGT) reported disastrous numbers. Target in particular took a severe blow from ordering way too much inventory in discretionary categories such as appliances and sporting goods.

Not to be outdone, WMT stock also crashed on its own earnings report. This happened as the company admitted to ending up with roughly 30% more inventory than anticipated as consumer demand rapidly decelerated for non-essential goods.

Overall retail sales are still going strong, to be sure. However, sales of food and gasoline are hardly the same, in terms of economic benefit, as sales of televisions, grills, refrigerators and other such big-ticket items.

With Walmart shares down 20% and Target shares down an incredible 36% just over the past month, traders expected a similar plunge from Costco. However, the club retailer managed to surprised the street.

Costco’s Third-Quarter Earnings Weren’t So Bad

Given the big misses from Walmart and Target, investors expected the worst for Costco as well. Instead, Costco delivered a solid set of results. It started with revenues. U.S. in-store sales grew an amazing 16.6%. Other markets were slower, with international up 6% and e-commerce up 7%. Still, nothing to complain about.

It is worth noting, however, that the increasing price of gasoline drove much of the sales growth. Excluding gas price increases, Costco reported that sales would have been up 10.7% in the U.S. instead of 16.6%.

Given the volatile nature of gas prices, this revenue growth could reverse in coming quarters.

Regardless, the gas business has been a big plus for Costco since, as prices soar, getting a good deal on fuel is more important than ever. This increases the value proposition of the Costco membership card.

Speaking of that value, some analysts had been looking for Costco to announce a membership price hike. It’s been years since the last increase. And given highly inflationary conditions now, there would likely be little customer pushback to such a move.

Still, management opted to hold off on making that move until a later date. That gives up some potential profits now, but is probably good as a long-term branding and customer loyalty decision.

COST Stock Verdict

The bottom line on Costco is simple. This is a best-in-class operator. The company’s sales dazzled again in Q3, and it was largely able to keep its profit margins intact as well, unlike its direct peers. However, Costco is trading at a high valuation relative to its peers. Costco is trading at at 32x forward price-earnings ratio, compared to Walmart’s 19x and Target’s 15x.

If you think retail is close to a trough and can turn the corner soon, than maybe it makes sense to pay up for quality and buy COST stock today.

However, that low point for retail probably isn’t here yet. After all, just weeks after its earnings disappointment, Target shocked investors with another cut to its forward guidance. And other retailers such as Gap (NYSE:GPS) have also posted downbeat numbers in the interim.

Costco is making the best of a bad situation. Give management a ton of credit for that. However, it’s still risky to buy COST stock here given the industry-wide problems. And that’s doubly true given Costco’s P/E multiple remains at a far from cheap 32 even amid the retail sector’s struggles.

On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.

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