Time To Buy Bulk In Costco Stock?

By Will Ashworth | August 17, 2011 AAA

One of Michelle Obama's favorite stores, J. Crew, opened its first Canadian location August 18 to crowds of disappointed customers. It turns out the retailer is charging around 15% more in Canada versus the U.S. for the same item, this at a time when the Canadian dollar is worth more than the U.S. dollar. As a Canadian, I find this price gouging abhorrent. However, it's good to know not all American retailers are so driven by greed. Costco (Nasdaq:COST), which has been in Canada since 1985, understands that Canadians know how to comparison shop. As a result, it tends to sell items for the same amount on both sides of the border. Its fair pricing policy is one of many reasons to own the big-box retailer's stock. Here are some others.

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Same-Store Sales
Costco had a strong July to go along with an even better June, and with one month left in its fiscal year. Double-digit same-store sales growth in fiscal 2011 is looking very realistic. Year-to-date, same-store sales are up 10% due to 7% growth in the U.S. and 16% internationally. Averaging 12% for the June-July period, it beat both BJ's Wholesale (NYSE:BJ) and Target (NYSE:TGT), which averaged 8.3% and 4.3% respectively. Wal-Mart (NYSE:WMT) doesn't report monthly sales, nor does it report quarterly comparables for its non-U.S. stores. Costco stores continue to benefit from a difficult economy. Costco, to a certain extent, transcends income levels, but certainly its average customer possesses a higher income than those at Wal-Mart.

Stock Performance
As they say in the mutual fund ads, past performance is not an indicator of future success. While that's true to an extent, knowing that Costco's stock has been in the black in nine out the last 11 years, including this year, when the S&P 500 is down almost 10% with four months to go, should be reassuring. Successful investing isn't always about hitting homeruns, but simply getting on base. Averaging 15% total returns over the past 15 years with most of it coming from capital appreciation rather than dividends, its stock is about as solid as they come; especially when you consider its ability to generate revenues and profits in good times and bad. Not many retailers can match it.

Valuation
This is where it gets tricky. Currently, Costco's enterprise value is 8.9-times EBITDA. That's much higher than both Wal-Mart and Target. Further, BJ's Wholesale sold itself earlier this summer to Leonard Green & Partners and CVC Capital Partners for $2.8 billion or 6.2 times EBITDA. In addition, Costco's trailing 12-month P/E ratio is 23.4, considerably higher than the S&P 500's at 13.6. The question is whether this premium is justified. Certainly, over the 15-year period, the answer is a resounding "yes". Costco's return beat the index by 910 basis points annually over those 15 years. Investors are usually willing to pay more for quality. If you're still concerned about overpaying, and you should be with its stock just 11.4% off an all-time high of $83.95; remember that Costco's current valuation is equal to its five-year average for P/E, P/S and P/B. More importantly, its P/S is one-third the index at 0.4 times. Lastly, it's one of the few large retailers with a net cash position on its balance sheet. Smart and safe is always a good combination.

The Bottom Line
CEO Jim Sinegal is 75 years old. The fact that he's still running Costco has a lot to do with its values. J. Crew could learn a thing or two about that. At the end of the day, Costco is a long-term, stick-it-in-the-drawer kind of stock. The future will take care of itself. (For additional reading, check out The 4 R's Of Investing In Retail.)

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