Will Costco Wholesale Corporation (NASDAQ: COST) Head Lower In 2018?

January 08, 2018, 18:17 pm ET, BY Simon M.- Contributor| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

Costco Wholesale Corporation (NASDAQ: COST) recently announced its Q1 fiscal 2018 earnings report, which indicated strong comparable sales growth figures. However, the significant comp sales growth was not accompanied with a commensurate margin expansion, which is why some analysts and investors believe that Costco stock is heading lower in 2018.

Article Summary

Costco had a stellar Q1 fiscal 2018 characterized by growth in comp sales.

The retailer seems to have withstood the Amazon threat to its business model.

The company is focused on increasing its market share instead of growing margins.

Here’s the trading report on COST.

The company seems to have successfully contained the threat from Amazon.com, Inc. (NASDAQ: AMZN) given the comp sales growth that the wholesaler has recently reported. Despite the company’s impressive revenue growth in the recent past, its margins have remained constant with gross margins remaining stuck around 14%.

Costco’s operating margin is also stuck around the 3% region, which is quite low for any business, and has been the main reason why some investors have begun shorting the stock. The company’s tiny margins means that even as its stock price keeps rising, the company cannot return more value to its shareholders due to the small margins.

The company might still have a promising future given the passage of the tax reform bill, which would reduce its effective tax rate from the current 33% to 21%. The company’s shareholders are also likely to benefit from the repatriation of non-US funds, but this is likely to be a one-time benefit.

The recent earnings call revealed that Costco’s management is not keen on margin expansion, but is focused on growing its market share by using lower prices as leverage. Therefore, the retailer is counting on sales growth to increase overall revenues and to generate EPS growth.

The company is using the same strategy applied by Wal-Mart Stores Inc (NYSE: WMT) in the 1990s in order to gain market share and become the leader in the US retail industry. This strategy has also proven effective for Amazon, which has even smaller margins than Costco’s, hence, characterizing the retail industry as a zero sum market.  

Much of Costco’s profits are generated from its membership fees, which the retailer is keen on popularizing in order to attract more customers. Despite Costco’s lows margins, the retailer has a lot going for it, which could make for a very profitable 2018, but there is a risk that its stock price might head lower in 2018.

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