Bet against Costco at your peril

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The knock on Costco Wholesale Corp. is that the retailer has become so gigantic – nearly $100-billion (U.S.) in revenue – that it's increasingly difficult to move the needle and deliver sizable profit gains, especially with its razor-thin margins.

The skeptics have been punished. The retailer hit an all-time high Thursday, approaching $100 per share, on the news of August sales gains that trumped Wall Street expectations.

Costco reported same-store sales – sales at locations open at least one year – gained 6 per cent in the four weeks ended Aug. 26; analysts' expectations were for a number around 4 to 5 per cent.

"Looking ahead, we expect Costco's comps growth to reaccelerate on easing prior-year comparisons starting in October, and the return of inflationary gas prices," says analyst Dan Geiman of Seattle-based research firm McAdams Wright Ragen.

Mr. Geiman says with Costco trading at more than 23 times his fiscal year 2013 earnings estimate, "we see limited upside in the near- to mid-term," so he reiterates his "hold" rating, while raising his target price to $98. (Costco closes its 53-week fiscal 2012 year Sunday.)

It's a tempting hypothesis. In January, when the shares were $80, I looked at its forward P/E of 21, its size, and described it as "a stock that is no sure bet to replicate its past gains." (And, "also not a good stock to bet against.")

Early January, as it turns out, was about its lowest point in 2012 for its forward P/E. The multiple has expanded to 23, per Standard & Poor's CapitalIQ, and the forward earnings estimate, with two quarters more of gains, is about 9 per cent higher, at $4.31.

So, still too pricey? Analyst Sean P. Naughton of Piper Jaffray, has a target price of $111, making him one of several Costco watchers with target prices above $100. Mr. Naughton uses a multiple of EBITDA, or earnings before interest, taxes, depreciation and amortization for his multiple; he says the shares' current price is 9.3 times his fiscal year 2013 EBITDA, whereas Costco has averaged a 9.8 multiple over the last five years.

"We believe this discount is unwarranted and [the shares] should actually trade at a premium given its reaccelerating unit growth prospects, higher contribution from membership fee income, consistent share gains/transaction trends and strong [return on invested capital]," he says. "We believe sales will continue to remain strong, especially if inflation in non-discretionary categories re-accelerates."

That, to quote my earlier views, makes Costco not a good stock to bet against.