Why Is Costco Trading at Tiffany Prices? Wait, Even Tiffany’s Not This Expensive
What do Costco’s apologists say in regards to its sky-high PE? A smart retail analyst at Chicago-based William Blair named Mark Miller rates Costco an “outperform.” Miller is fond of the stock because Costco is, he says, one of the only big retailers that consistently beats Amazon.com (AMZN) on prices. Costco is so good at the grocery business, he adds, it has succeeded at doing the seemingly impossible, stealing customers from grocery chains operating at super-thin margins. So its revenues have been growing a little faster than Wal-Mart’s and Target’s.
“Costco represents one of the best opportunities to invest in the growth of value retailing,” Miller explained in a report on October 4, “and the steady 4%‐plus same‐store traffic growth continues to be driven by growth in food and consumables (at the expense of conventional supermarkets).”
Got it? Even if Wal-Mart and Target take over the grocery business and Amazon takes over the rest of the world, Costco will still be chugging along. Miller and others are projecting the company will earn around $4.60 a share in 2013, a 15% rise from the $4 they’re projecting this year. So dive in—even if that means you have to pay 23 times those projected 2013 earnings. Assuming the PE stays steady, you’re looking at a 15% to 20% return a year from now.
That’s the bull argument. Now let’s run through a few reasons why it makes no sense whatsoever to pay 23 times Costco’s earnings.
One, though Costco is projected to have slightly better EPS growth than Target or Wal-Mart in the coming year, it has a long history of earnings growth that is not noticeably better than its rivals’.
Two is sales growth. If you look more closely, you won’t see Costco outrunning Wal-Mart or Target. Not if you look at revenue per share. If you have YCharts Pro, you can see this easily.
If you don’t have YCharts Pro, let me give you the numbers: Wal-Mart’s revenue per share is up about 50% in the past five years and Target and Costco are up about 45% each. So Costco’s sales are not really rising quickly—not for investors, anyway.
The third for skepticism is profitability. Costco has proven to be unskilled at producing high profits. Wal-Mart and Target have far better profit margins.
Four: Costco’s balance sheet. If Costco was far less leveraged than Wal-Mart or Target, that would be a superb reason to own its shares at a much higher PE ratio. Unfortunately, that’s not the case here. Costco’s $14 billion in liabilities are 36% of its enterprise value. Target’s liabilities are 40% of its EV, and Wal-Mart’s are 50%. The differences aren’t huge.
The best way to discount the modest differences between the three companies’ balance sheets is to compare their “enterprise multiples.” That’s enterprise value divided by trailing earnings before interest, taxes, depreciation and amortization.
Again, you need YCharts Pro to see a charge of the three, but for those of you who don’t have Pro, I’ll tell you that Costco’s enterprise multiple is near 12 times while the other two are near 8 times.
Now, I can already hear my mom asking me about Costco’s most valuable asset: The tremendous loyalty of its customers. Millions of shoppers pay $50 or $60 a year for a Costco membership, because they’re sure they’ll more than make that back in savings over the year. My mom is totally addicted to her thrice-weekly visits to Costco’s marvelous store in Covington, Wash. She cheerfully passes by her local Safeway (SWY) and Fred Meyer grocery stores to purchase Costco’s meats and produce. They are superior, she insists.
And hey, I’m a member. Where else can you buy a few pounds of hamburger ground on-premises, purchase gasoline at a nifty discount and also pick up a computer monitor? (Yes, the monitor I’m looking at right now hails from Costco.)
My point is that I don’t dismiss that kind of loyalty lightly. I just think you should purchase it for a lower price.
If you want a play on loyal retail shoppers, why not put a ring on Tiffany’s finger? That company isn’t losing customers to Amazon or Wal-Mart. Tiffany has a lower enterprise multiple (10, versus Costco’s 12), less debt (liabilities are 22% of enterprise value, versus Costco’s 36%), a lower PE ratio (15 times 2013 projected EPS, versus 23), similar projected EPS growth (14%, versus Costco’s 15%) and vastly higher profit margins (10% versus 2%).