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Stock Analyst Update

Outbreak Leads Costco's Sales Sharply Higher

Shares of the wide-moat firm seem rich for long-term investors.

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Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

We plan to lift our $249 per share valuation of wide-moat Costco (COST) by a mid-single-digit percentage, reflecting skyrocketing second-quarter sales spurred by the COVID-19 outbreak. While the surge should persist into at least the third quarter, we do not believe Costco’s long-term prospects have changed. We still expect mid-single-digit top-line growth and 3% operating margins long term. The duration and severity of a U.S. outbreak could meaningfully affect Costco’s near-term prospects (with stock-up benefits offset if shoppers remain home as cases rise), but we suggest long-term investors await a more attractive entry point.

Adjusted second-quarter comparable sales rose 7.9%, well past our 5.5% target, and February’s mark neared 12%. Still, management attributed only about 3 points of the latter to the outbreak, with the remainder reflecting strong sales across a wide range of categories.

Management stated supplies of Chinese-made items are recovering as factories come online and goods work their way to distribution facilities and warehouses. We believe Costco is better insulated from supply disruptions than most as its changing, limited assortment and flexible warehouses allow it to substitute out hard-to-find products, but the recovery should push the lineup back toward Costco’s most advantaged items.

Sales have been exceptionally brisk over the last two weeks, and we are encouraged that the traffic has also led to sales of items unrelated to outbreak preparedness, such as patio furniture and lawn and garden items. We assume some purchasing is pulled-forward demand but suspect the sales environment will endure as long as fears remain high (unless the outbreak forces significant store closures). Still, the spike does not alter our view that while Costco’s membership model, concentrated purchasing power, and vendor relationships protect it from competitive pressure, its market valuation assumes a degree of execution perfection with which we are uncomfortable.

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Zain Akbari does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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