Key Points
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Costco’s June net sales rose 10.6% year over year to more than $29 billion.
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Strip out gas prices and currency, and comparable sales growth cooled to 7%.
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At about 46 times earnings, the stock has almost no room for a merely good month.
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Membership-based wholesale retailer Costco Wholesale (NASDAQ: COST) reported sales for the retail month of June after the market closed on Wednesday, and at a glance, the numbers looked strong. Net sales rose 10.6% year over year to about $29.2 billion for the five weeks ended July 5. U.S. comparable sales, a measure of sales at warehouses open at least a year, climbed 10.6%. And digitally enabled comparable sales jumped nearly 21%. The company also declared its regular quarterly dividend of $1.47 per share.
And yet the stock fell about 4% as of this writing, slipping to about $913 and landing roughly 17% below its 52-week high.
So why would investors sell a report that, on its face, looks like more of the steady growth Costco is known for?
Here’s why Costco stock declined
The answer is in the fine print. Strip out gasoline prices and foreign exchange, two things Costco doesn’t really control and that can flatter or dent any single month, and June looks a good deal more ordinary. On that adjusted basis, U.S. comparable sales rose 7.6% year over year, and total company comparable sales rose 7%.
Much of the gap between the adjusted and reported figures came from higher gas prices during the period.
Seven percent is still a fine number. The problem is the trajectory. Costco’s adjusted total company comparable sales ran 7.8% in April and 8% in May, so June’s 7% is a step down rather than a step up. The U.S. told the same story: adjusted comparable sales there eased to 7.6% in June, down from 8.7% in May.
Of course, the business isn’t faltering. Digitally enabled sales, adjusted for currency, actually accelerated to 21.5% in June. And membership, the recurring high-margin engine underneath everything Costco does, keeps renewing at rates most retailers can only envy. For the first 44 weeks of the fiscal year, adjusted comparable sales are running at a healthy 6.7%.
But Costco doesn’t get graded on a normal retail curve. It gets graded against its own sky-high valuation.
Why a good month wasn’t good enough
As of this writing, Costco trades at about 46 times earnings. That is rich for any retailer, though it is down from the mid-50s the stock commanded earlier this year. For context, the S&P 500 trades closer to 25 times.
Investors have long been willing to pay that premium for Costco’s consistency and the recurring income from its membership fees, and understandably so. The problem, I think, is what the stock’s valuation already prices in: years of uninterrupted mid-to-high single-digit comparable sales growth and steady profit gains, with no soft patches allowed.
So when a monthly update shows the underlying growth rate cooling, even a little, the reaction can look outsized next to the news. A 7% adjusted comp would be a triumph at most retailers. At Costco’s valuation, however, it may not be enough to live up to investors’ expectations.
The dividend, meanwhile, is a nice gesture. But at a yield of about 0.6% it was probably never the reason to own the stock.
So is this 4% dip a chance to buy one of the market’s best businesses? I don’t think so, at least not yet.
Costco stock has been stuck in the same spot for a while: a great company priced as if nothing ever slows down. June is a small reminder that growth ebbs and flows, even at a business this well run.
I wouldn’t bet against the company. Costco keeps signing up members, keeps holding on to them, and keeps growing online sales. And a 4% pullback does make the stock a touch less expensive than it was on Tuesday. But a touch less expensive arguably isn’t enough to make the stock a buy.
Ultimately, at about 46 times earnings, I’d want a wider margin of safety before putting new money to work. I’m content to wait on the sidelines for a price that leaves room for the occasional ordinary month. Shareholders who already own Costco, of course, have far less to worry about. This is a company worth holding for the long haul.
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Daniel Sparks and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale. The Motley Fool has a disclosure policy.
