Costco Wholesale (COST 1.03%) reported sizzling sales and earnings growth when it released its earnings report for the fourth quarter of fiscal 2020 last Thursday. Net sales jumped 12.5% year over year to $52.3 billion, while adjusted earnings per share reached $3.04: up 13% year over year.
Despite the strong showing, Costco stock sagged in after-hours trading on Thursday and fell sharply early in the day Friday. However, the stock has rallied since then and now sits comfortably above its Thursday closing price. Let's take a look at why investors have already changed their tune about Costco's results.
Costco Stock Performance, data by YCharts.
High expectations
Costco stock has more than doubled over the past three years, far outpacing the S&P 500's 33% increase over that period. Year to date, Costco shares have risen 20%, while the S&P 500 is up a little more than 3%. Costco's strong stock market performance means that shareholders routinely have elevated expectations.
Investors could certainly find some things to quibble with in Costco's Q4 earnings report. The company's high-margin travel business continues to suffer from weak travel demand due to the COVID-19 pandemic. Gasoline demand remains depressed for similar reasons. Additionally, Costco is still paying employees an extra $2/hour to work during the pandemic, at a cost of $14 million per week. That premium pay will continue for at least the first eight weeks of fiscal 2021 and could be extended further.
That said, these are all short-term headwinds. Gasoline demand has already recovered most of the way to 2019 levels, and travel bookings for 2021 are starting to pick up. By this time next year, widespread vaccine availability could get those ancillary businesses back to normal while allowing Costco to withdraw the $2/hour bonus pay.
Furthermore, Costco's Q4 adjusted EPS of $3.04 easily beat the average analyst estimate of $2.84. And while Costco's strong sales growth wasn't news -- it had previously reported that adjusted comparable sales surged 14.1% in Q4, with double-digit growth in all regions -- that was double the growth pace Costco achieved in the first three quarters of fiscal 2020.
Plenty of growth potential ahead
During Costco's recent earnings call, CFO Richard Galanti acknowledged that the pandemic may be contributing positively to the warehouse club giant's sales growth. Lower spending on restaurants and travel is boosting demand for food (especially fresh food) at Costco and driving growth in discretionary categories.
Image source: Costco Wholesale.
As the pandemic recedes, it's reasonable to expect some sales pressure as consumer spending shifts back toward experiences. That said, Costco's ancillary businesses like gasoline and travel will benefit from that shift. Moreover, Costco is gaining market share. With the pandemic forcing many weaker retailers to shrink or go out of business, some of those gains are likely to stick.
Costco also has a significant long-term growth opportunity with respect to big-ticket items. In March, it spent $1 billion to buy former Sears subsidiary Innovel Solutions, which specializes in middle mile and last-mile delivery and installation of bulky items, especially appliances.
Appliances in particular are a key growth category for Costco. The retailer only became a major player in appliances a few years ago but is already the No. 7 appliance dealer in the U.S. -- and growing quickly. The Innovel acquisition is weighing on earnings right now, but it could enable long-term market share growth in appliances by reducing delivery costs, enabling Costco to undercut the competition on price.
A pricey stock that's worth the cost
Costco stock certainly isn't cheap. After recovering from their post-earnings drop, the shares change hands for about 37 times the company's projected EPS for fiscal 2021.
However, long-term investors will likely find that this is a fair price. Costco has over $12 billion of cash on its balance sheet, some of which is likely to be returned to shareholders soon in the form of a special dividend. Just as importantly, the retailer has tremendous sales momentum and plenty of room to gain share in the U.S. and abroad. While Costco stock is unlikely to double again in the next three years, there's plenty of long-term upside for patient shareholders.
