Costco Balances Risk-Reward

Costco Wholesale Corporation (COST) continues to be a dominant retail wholesaler based on its breadth and quality of merchandise offered. The company’s strategy to sell products at heavily discounted prices has helped it to remain on a positive growth track despite recent economic downturn as cash-strapped customers continue to see it as a viable option for low-cost necessities.

Having continued to deliver consistent comparable-store sales growth, Costco is strongly positioned in the warehouse club industry. Costco recently posted healthy sales data for the month of December. The company sustained its sales, although the rate of growth decelerated.

After a 9% increase in November 2010, Costco’s comparable-store sales for December rose 6%, reflecting comparable sales growth of 4% at its U.S. locations and 12% at its international divisions.

We are also encouraged by the company’s expansion strategy. Costco remains committed to opening new clubs in domestic and international markets. The company plans to open 27 net new locations in fiscal 2011, including 15 in the U.S. Its diversification strategy is a natural hedge against risks that may arise in specific markets.

Costco continues to make prudent use of its free cash flow through share repurchases and dividend payments. This underlines its efforts to maximize shareholder returns under trying economic conditions. Moreover, the company’s current cash resources are adequate to support expenditures associated with its ongoing expansion initiatives.

However, Costco faces stiff competition from BJ’s Wholesale Club Inc. (BJ) and Sam’s Club, a division of Wal-Mart Stores Inc. (WMT). These two rivals follow similar business models as they market high volumes of merchandise at low prices in membership-only warehouse clubs. Thus, aggressive pricing to gain market share and drive traffic amid stiff competition, may depress sales and margins.

Given the pros and cons, we prefer to have a long-term ‘Neutral’ rating on the stock. Moreover, Costco holds Zacks #3 Rank, which translates into a short-term ‘Hold’ rating, and correlates with our long-term recommendation.

COSTCO WHOLE CP (COST): Free Stock Analysis Report

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