Costco Stock: Why It Remains a Great Investment

The market crash has driven stocks into a bear market panicking many investors as strong companies with solid results see their shares tank.

It’s a market that seems to have no safe havens as the vague specter of inflation has cast a dark shadow over the entire market, but pandemic stocks, technology companies, and the entire retail sector.

Costco (COST) – Get Costco Wholesale Corporation Report has not been immune to the drop. Despite the warehouse club operating pretty much as it always has, steadily adding members while retaining existing members, the chain has seen its share price fall 22.83% in the past six months.

That’s a big drop for a chain which has been a very steady stock, usually moving upward while also paying a dividend. Costco’s share price drop, however, has nothing to actually do with the company’s performance. Instead, the company has fallen victim to broad concerns about retail in general.

Target (TGT) – Get Target Corporation Report, for example, saw its shares lose over 25% in value after it reported first quarter results. The chain grew its same-store sales, which was impressive given that it had seen that metric rise by 22.9% in previous-year quarter. The retailer faltered when it came to profits as earnings were cut in half year-over-year due to rising costs and supply chain issue.

Never mind that Wall Street has taken Target’s strength for weakness (making money and gaining customers under these conditions is impressive), Costco shareholders have even less to be worried about.

Why Is Costco So Strong?

Retail stocks, including Target and Costco, have suffered due to rising prices (inflation), supply chain issues, and fears over consumer spending drops. These are real concerns, but Costco has a lot of protection from those issues. The warehouse club operates on a membership model. Its profits come largely from selling memberships, not on the goods its sells its members.

Costco offers members the promise of low prices in exchange for a membership fee. The company offers a limited selection to keep prices down and it has enormous bargaining power with suppliers.

It’s possible that inflation will drive prices higher on some key Costco items, but the company can simply pass those increases on without adding a markup. That makes the chain a value proposition for shoppers as these factors impact all retailers.

Costco has been able to hold its own on gross margin, according to CFO Richard Galanti speaking during the company’s second-quarter earnings call.

“Moving down to the gross margin line. Our reported gross margin in the second quarter was lower year over year by 32 basis points but up 5 basis points, excluding gas inflation,” he said.

Basically, aside from gas — which is generally cheaper at Costco than anywhere else — the company maintained its margin. It also grew its same-store sales by 11.1% excluding gas while its income rose as well.

“Net income for the quarter came in at $1.299 billion or $2.92 per diluted share. Last year’s second quarter net income came in at $951 million or $2.14 per diluted share,” Galanti shared.

Membership Is Costco’s Key Metric

Unlike a traditional retailer, sales aren’t the key metric for Costco. Membership tells investors more about the health of the company than anything else. The warehouse club needs both retain members and add new ones.

It has done that, according to Galanti.

“In terms of renewal rates, they continue to increase. At second quarter end, our U.S. and Canada renewal rate stood at 92%, up 0.4 percentage point from the 12-week earlier at Q1 end. And worldwide rate, it came in at 89.6%, up 0.6% from where it stood 12 weeks earlier at Q1 end,” the CFO shared.

Costco has seen its renewal rates go up as more members auto-renew. The warehouse club has also seen more of its members opt for the higher-priced Executive Membership, “who, on average, renew at a higher rate than non-Executive members,” Galanti shared.

Membership has been growing (as it steadily has) as well, according to the CFO.

In terms of the number of members at second quarter end, member households and total cardholders, total households was 63.4 million, up 900,000 from the 62.5 million just 12 weeks earlier; and total cardholders at Q2 end, 114.8 million, up 1.7 million from the 113.1 million figure 12 weeks ago. At second quarter end, paid Executive Memberships stood at $27.1 million, an increase of $644,000 during the 12-week period since Q1 end. Executive Members, by the way, represent now 42.7% of our total membership base and 70.9% of our total sales.

So, while Costco’s share price has suffered due to broader concerns and general market panic, the chain’s business has not suffered. In a terrifying environment for investors, you could argue that Costco’s one of the safer bets as long as you’re willing to be patient.

In the short-term, stock prices may not reflect actual business results. Over time, however, the warehouse club will go back to posting steady share gains while also paying a dividend (and perhaps offering a bonus special dividend).