Costco's sales are strong, but valuation 'leaves no room for error,' says analyst

By James Rogers

Costco's current valuation 'has become extremely stretched,' says Truist Securities

Costco Wholesale Corp.'s valuation and its recent membership-fee increase are in the spotlight after the company reported fourth-quarter results late Thursday.

In a note released Friday, Truist Securities analyst Scot Ciccarelli highlighted Costco's strong sales and improving margins, but said that the company's valuation "leaves no room for error."

Truist recently downgraded the stock to hold, saying that the current valuation, which is about 52 times earnings per share "has become extremely stretched even for COST," Ciccarelli wrote. "Recent operational changes (scanning membership cards on entry and recent packaging changes) could prove to be negatives at the margin for a stock that has virtually no room for error," he added. The analyst firm raised its price target on Costco's stock (COST) to $909 from $873.

Related: Costco's stock slips as quarterly sales come up short and fee hike won't immediately lift revenue

However, BMO Capital Markets analyst Kelly Bania described Costco's valuation as "not too big or bulky," adding that the stock is still an attractive proposition. "We continue to be encouraged by COST's momentum in Ecommerce growth and while valuation has expanded to new highs, COST remains attractive in our view," she wrote in a note released Thursday. BMO Capital Markets reiterated its outperform rating and raised its Costco price target to $980.

Costco reported fourth-quarter sales of $78.2 billion, a 1% increase on the same period last year, but below the FactSet consensus of $79.91 billion. The retailer's shares were down 1% in premarket trades Friday.

The company's fourth-quarter results were also the first since its closely watched membership-fee increase, which Wall Street had been eager to see. Costco announced the membership-fee hike in July, and it came into effect this month, marking the company's first increase in seven years.

Related: Costco stock rallies after membership fees raised for first time in 7 years. But high expectations could limit gains, analyst says.

"From a member reaction perspective, I'd say we haven't really heard a significant member reaction," Costco CFO Gary Millerchip said during a conference call to discuss the results. Costo has seen "no real change" in the company's membership renewal rates, he added.

"The last price increase took effect seven years ago (June 2017), foregoing the company's typical 5-year price hike cadence as mgmt waited for the COVID impact to slow, inflation to dissipate, and greenshoots to emerge in non-food categories before implementing higher rates," J.P. Morgan analyst Christopher Horvers wrote in a note released Thursday.

J.P. Morgan noted that, due to deferred accounting, Costco expects minimal impact of the membership-fee increase in the first half of 2025, with the vast majority hitting the company's profit and loss statement from the second half of 2025 to the first half of 2026. Set against this backdrop, J.P. Morgan is now modeling membership-fee income growth of 10.9% and 8.9% in fiscal years 2025 and 2026, respectively. The analyst firm raised its Costco price target to $945 from $925 and maintained its overweight rating.

Related: Costco made these subtle changes, adding enough 'friction' to prompt a downgrade

"We anticipate the recently enacted membership fee increase will be largely reinvested, further aiding sales, comp, and traffic growth over the next 12-18 months," Stifel analyst Mark Astrachan wrote in a note released Thursday. Stifel, which has a buy rating for Costco, raised its price target to $925 from $915.

Of 38 analysts surveyed by FactSet, 21 have an overweight or buy rating, 16 have a hold rating, and one has a sell rating for Costco.

Costco shares are up 36.6% in 2024, compared with the S&P 500 index's SPX gain of 20.5%.

-James Rogers

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09-27-24 0907ET

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