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Is Costco About To Pop?

consumer discretionary Nov 09, 2022

Price Target: $575 (20% upside)

Current Price: $480 

Target Date: Q3 2023

Stock: Costco (COST)

Before we even dive into today's pick, we need to know, who doesn't love Costco?

As a child, I remember there was nothing better than cruising down the aisles and eating free sample, after free sample.

And while I didn't realize it back then, Costco was slowly sucking me into their funnel. And I'm proud to admit that after years of free food, I've finally become a Costco member.

As one of the original subscription plays, Costco is the definition of a company that seems to only get better with age. 

They've not only been making their members happy for years, but they've also made their investors happy too (up ~23,000% all-time).

Even with the stock down 14% this year, we still believe that Costco is in its "early innings" and has plenty more upside & growth to come.

If you're on team Sam’s Club, BJ's, or some other wholesaler/grocer -- give us some time to try and convert you.

Let's get into our sales pitch 👇 


We're ashamed to admit that this is the first time we're covering Costco. And no we're not getting paid to write them a positive review.

While we are fanboying over them, it's more a testament to our love of their product and our loyalty than anything else.

And in that vein, here at Moby, we have never and will ever take any form of payment for reviewing a company.

Unlike others (**cough, cough Motley Fool, Seeking Alpha, etc.**), our entire platform is built with trust and transparency in mind.

So with that weird rant out of the way, let's actually review Costco as an investment.


Costco Overview:

Like we said before, we know that Costco is down this year.

However, when you compare it to the market, which is down 21%, Costco has actually held up pretty well.

Therefore we view this recent downturn as part of the market sell-off rather than due to any inherent fundamental risks.

And actually, when looking at their business, we see 2023 could be a game-changing year for their company.

At a high level, we see them taking advantage of this downturn by re-investing in their business across several key areas, such as: 

  • International Expansion

  • Growth of domestic market share

  • Profitability growth

  • And "special & unique" opportunities for growth (more on this below)

Let's double-click into each one of these points.


International Expansion:

While Costco is a huge name here in the US, internationally, its footprint isn't nearly as large. And this represents a massive opportunity for them.

That's because the value proposition of their business holds up well across geographies and in other countries, there really isn't much competition.

This lack of competition across borders allows Costco to then do two things really well:

  1. The first is that they can focus their growth here over the long term, instead of optimizing for short-term gains. While this may sound obvious, Costco's size really makes this more possible. Because revenues from overseas will represent such a small part of their overall business, Costco can afford to invest responsibility for the right long-term necessary infrastructure -- instead of needing to appease shareholders today.

  2. The second thing they can do well is then capitalized on market share internationally over the long run. Because their business doesn't need profits today, and because it's a highly capital-intensive business that takes time to stand up, Costco can make the right investments today -- knowing there's a small chance they're disrupted.

Therefore we anticipate that this international growth can eventually contribute an accretive 3-6% annual growth to their margins due to these new lower-cost centers.

With their first location opening up in Sweden this week, and several other European countries opening up in the coming years, we'll be able to see this play out in real time before it's priced into their stock.

Past Europe, they just opened up a location in New Zealand and are set to open up 8 locations in China over the next several years.

And this is just the tip of the iceberg because Costco is reported to 2x their locations both in Japan and Canada too!

What we're seeing here is the beginning stages of a major international expansion, that will take years to play out -- that we can get on the ground floor of today.


Domestic Expansion:

And while Costco is growing internationally, they're far from ending their growth here in the US.

While there are fears that they've fully saturated the market here, our research draws the far opposite conclusion.

Looking at major metro areas, we forecast that LA, NY, & FL could support another 50+ clubs.

And it's rumored that Costco is starting to approach secondary regions like Bismarck, ND & Little Rock, AR.

All in all, we forecast for an additional 15-20 new clubs to open up every year, for the next several years.


Profitability Growth:

So the growth box is definitely checked off. But what have we learned over the last year?

While growth is great, it's only great if it can be done profitably and at scale.

And while we believe that Costco's international expansion will eventually add significant margin expansion, in the short run, they're still making positive strides too.

Looking at their business further, we see that Costco successfully capitalizes on consumer trends quicker than you would think.

For example, in areas like apparel and electronics, where many others are struggling, Costco has scaled its inventory effectively while also keeping demand higher than its peers.

With the holiday season coming up, and savings being more important to the average consumer than any time over the last decade, we think Costco could surprise to the upside when they report next quarter's numbers.

And this topline growth is set to see it flow through to the bottom line as they're projecting to grow EBITDA by over 23% in the next few years vs. 8% (which is what they did from 2015-2020). This is insane!

On the heels of a very uncertain macro backdrop, it speaks volumes to their business that they're not only able to sustain demand but also expand profitability too.


Costco Outlook:

This was a lot to digest -- let's quickly summarize the three main points:

  • Costco has a massive international expansion plan that will take shape over the next few years.

  • Costco is still growing its domestic footprint

  • Costco's "moat" is that they can not only grow, but grow in a profitable way

Think that's it? If you thought the answer was yes, you were wrong.

Costco also has two major upcoming events for 2023.

While we're not 100% sure WHEN this will happen, it's anticipated that Costco will raise membership prices as well as give out a special dividend to its shareholders.

With a 90% renewal rate and a 10% projected increase in membership cost, Costco can essentially increase its total revenues by up to 3% with no additional cost!

Additionally, with $10B of cash on their balance sheet, and a prior reference of a $4.4B special dividend paid in November 2020, we anticipate a similar amount paid out upon this announcement.

At its current market cap, that would be over 2% in extra yield you would get as a Costco shareholder!

We could keep going on for days about Costco, but at this point, we hope you get it.

Costco is a profit-cruising missile that has plenty of fuel left in its tank! We love this stock and plan to hold it for years.

Rating: Overweight

Market Cap: $216B

P/E Ratio: 37x

Dividend Yield: .74%

Risk/Reward: Medium/Medium