Costco (COST) Not Immune to Retail’s Slump

The conventional wisdom held that Costco (COST) would fare better than most because of its wholesale prices for bulk purchases. Thus far that theory has shown to be pretty true, at least in comparison to most retailers. But as the warehouse retailer reported third quarter earnings Thursday morning, it was clear that the higher end items for sale at Costco were not selling as well as analysts hoped. Discretionary spending continues to be a sore spot for retail as consumers put bigger purchases off for a hopefully more certain future. This has been a continuing theme for big-box retailers reporting recently including The Home Depot (HD) and Lowe’s (LOW) last week.

“Costco down. Everyone says the consumer has traded down benefits the wholesalers. You look at the earnings where they miss slightly and you wonder what’s happening. They’re getting hurt by a couple of things here. One is the higher end retail of the tape, discretionary, not selling as many as their flat panel TVs, et cetera. Also, what hurt Costco is not a good litmus test for the American consumer because the strong dollar hurt their international sales and lower gas prices year over year hurt their domestic sales because when they were selling gas at $4.” Squawk on the Street 5/28/2009

The results also took a hit from a stronger dollar producing international same store sales slumping 12%, which was far worse than U.S. comparable sales that were also down 5%. Costco reported earnings of just 48 cents per share which missed consensus estimates by 5 cents. Revenue sagged by 5% in the quarter finishing with $15.8 billion of sales in the period.

Even though the past quarter was not especially impressive by Costco, considering competitor BJ’s Wholesale (BJ) just reported a good quarter and raised guidance, Ockham has an Undervalued rating on COST shares. As Costco’s fundamentals have started to slack recently, the stock price has fallen to low enough levels to keep the shares attractive from our valuation methodology. Given the current fundamentals, Costco is not extremely undervalued, but we believe the stock could justify a price in the range of $53 to $60 given current sales and cash.

Costco Not Immune to Retail’s Slump

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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