If Competition Is For Losers, Buy This Stock

After the retail wreck a few weeks ago, we covered Target (TGT) in an issue of The Spill.

At the time, Walmart (WMT) was the top discount retailer search amongst financial pros.

Since that time, Costco has jumped into first place which piqued our interest.

Costco’s competitive advantage is so strong, that it is one of the few retailers that charges people a membership fee, just for the opportunity to shop in the store!

Despite fears of an economic slowdown, is now the time to get into COST? 

Let’s take a deep dive to see what this company is all about. 

Costco’s Business

Costco Wholesale Corporation offers memberships to its warehouses where it retails goods and grocery items.  COST has membership warehouses across the globe, where it sells its branded and private-label products. 

Customers love it because it offers bulk discounts on everyday items like candies, liquor, tobacco, deli products, appliances, electronics, health and beauty supplies, hardware, garden and patio products, sporting goods, tires, you name it. 

It also operates pharmacies, opticals, food courts, and gas stations

There are currently 830 membership warehouses, including 574 in the United States and Puerto Rico, 105 in Canada, 40 in Mexico, in Japan, 29 in the United Kingdom, 16 in Korea, 14 in Taiwan, 13 in Australia, 4 in Spain, 2 in France, 2 in China, and one in Iceland. 

Besides its physical locations, COST also has an e-commerce website in the United States, United Kingdom, Canada, Mexico, Korea, Taiwan, Japan, and Australia. 

Despite all the fears of the global economy slowing down, the company reported its net sales were $18.23 billion for the retail month of May. That’s an increase of 16.9% from May 2021.  

Financials

Obviously, inflation is a major concern among businesses today. And you’d think that COST would be struggling given the current environment we’re in, but the company has remained strong, thanks to its strong cash flow.

You see, while most retailers are scrambling to hike prices, COST can remain patient and selective. In fact, COST has $9.93 billion in cash from operations (TTM), which is incredible considering the sector median is $473 million.  

Even during the pandemic, COST figured out a way to increase its revenues, which they’ve done consistently for over a decade. 

Its been able to grow its revenue (YoY) 16.56%, which is significantly better than the sector median of 10.63%. Over the last 5-years COST has seen its revenues grow an average of 10.82%

What’s even more impressive is the company’s ability to generate free cash flow. In 2018, COST had a free cash flow of $2.8 billion, and in 2021, the firm nearly doubled it with a free cash flow of $5.3 billion. 

COST has a total debt of $9.04 billion. However, it is sitting on $11.83 billion in cash. Meanwhile, the company boasts a market cap north of $206 billion. 

For some of its competitors, rising interest rates will hurt, but COST has so much cash at hand and generates so much cash flow, that it is in a position to expand. 

Valuation

Stocks with a high P/E ratio have been getting smacked around in 2022, because of all the inflation fears and rising interest rates. Despite the relatively high P/E in COST, it’s actually in line with how it’s been over the last five years. 

As mentioned earlier, COST brings in plenty of revenues and free-cash-flow, so a relatively higher P/E won’t discourage investors from buying the stock. 

Another indication of Costco’s financial strength is that it pays a dividend. While it’s not much given the current share price, COST does pay its shareholders an annual dividend of $3.60 per share. 

If the valuation is COST’s weakest area, its strongest is clearly profitability. 

For example, COST has a return on total assets at 8.84%, which is insane, when you compare it to the sector median of 4.74%. 

And of course, something we mentioned earlier, cash from operations at $9.93 billion is in a different league from its competitors. Only Wal Mart can beat it at $17.56 billion.

And while Wal Mart has better gross profit margins and EBITDA margin, it is not growing revenues like COST is. 

In fact, at 16.56% revenue growth, Wal Mart wishes it could reach that level, which is currently at 2.34%. 

Furthermore, COST EBITDA growth (YoY) outshines WalMart again, at 14.71% vs. -11.67%. And even its smaller competitor BJ’s Wholesale, which is at 5.66%

Our Opinion – 8/10

Costco is one of the best-managed companies in the entire world. That’s evident by its ability to boost revenues, and EPS, year after year. 

Even during the pandemic, it managed to grow, and get better. 

That’s why we believe that shares should be scooped up on any type of weakness. 

The barrier of entry into this niche is very high. Besides Sam’s Club, which is owned by WalMart, and BJ’s Wholesale, there aren’t many players in the space. 

COST has proven it can expand and grow both domestically, and internationally, and we believe it will be a great stock to own for several years.