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Stock Strategist

Cash Flow and Growth Prospects Give This Retailer a Rare Wide Moat

Costco's superior cost advantages and potential for expansion remain compelling.

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Bucking the trend of most of our retail coverage universe,  Costco (COST) has improved its competitive position in recent years and now stands on the short list of retailers with wide economic moats, joining  Wal-Mart (WMT),  Amazon (AMZN),  Home Depot (HD), and  Lowe's (LOW). We believe that the competitive environment will remain intense, but Costco's membership and traffic trends remain solid, and we think the firm's long-term growth potential still appears compelling. Combining all these factors, we value Costco at $125 per share, which implies a forward price/fiscal 2015 earnings ratio of 25 and an enterprise value/EBITDA ratio of 11. While Costco's current multiple of 23 times fiscal 2015 earnings per share may be keeping investors on the sidelines, we believe the firm's cash flow generation and growth potential justify a premium multiple. With the shares trading at a modest discount to our fair value estimate, we think investors should keep this quality name on their radars.

Costco's Cost Advantages and Brand Equity Make Excess ROICs Sustainable
We assign Costco a wide moat because we believe its per-unit costs are structurally lower than those of most other retailers. Selling a narrow range of fast-turning products in bulk quantities allows Costco to maximize the benefits of volume purchasing and run operations very efficiently. By passing cost savings on to customers, Costco strengthens its perceived cost leadership, increases customer loyalty and spending, and bolsters its ability to charge membership fees, which help drive asset turnover and returns on invested capital higher.

Ken Perkins does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.