Costco Wholesale Corporation (NASDAQ:COST) has performed wonderfully for its shareholders in recent years, and just recently posted a great quarter, earning $1.24 per share, easily topping expectations of $1.06. However, with the recent pop in the share price, which is right at its 52-week high, is Costco Wholesale Corporation (NASDAQ:COST) still the best way to play discount retailers, or is one of its competitors worth a look now?
Costco in a Nutshell
Costco Wholesale Corporation (NASDAQ:COST) operates over 600 of its warehouse-style stores and has a paid membership of 36.9 million. The general strategy of Costco is to offer deep discounts on a wide range of merchandise, which produces high sales volume and inventory turnover. Virtually all of Costco’s merchandise is bought directly from manufacturers, and its low overhead and no-frills business model allows it to operate at an even lower profit margin than the other discount giants.
Costco Wholesale Corporation (NASDAQ:COST) has been growing aggressively, and in October the company announced its plans to accelerate this growth, and just recently, 14 new stores are set to open between now and the end of this fiscal year in August.
Valuation
After the recent gains, Costco trades at about 23 times forward earnings, which I find to be a bit expensive. The consensus calls for an average forward growth rate of 12.2%, which is impressive but I’m not sure it justifies such a premium valuation. Costco does have about $3.5 billion in net cash (cash minus debt) on its balance sheet, but even if you back this out, shares still trade at over 21 times earnings.
Raise the Dividend. More!
Also, Costco Wholesale Corporation (NASDAQ:COST)’s dividend leaves something to be desired. While it’s true that the dividend amount has been raised every single year since the company began paying dividends in 2004, the stock still only yields just over 1%, which is way under the peer average. The company did issue a $7 per share special dividend in late 2012, which was most likely for tax purposes and funded by issuing $3.5 billion in senior notes, which I’m not sure I like.
Alternatives
Costco competes with other large discount retailers, so I wonder if the others trade at a similar premium. The closest competitor is Wal-Mart Stores, Inc. (NYSE:WMT), whose Sam’s Club stores are very similar to Costco Wholesale Corporation (NASDAQ:COST). Surprisingly, even though the two companies have similar growth projections, Wal-Mart Stores, Inc. (NYSE:WMT) trades at a much lower valuation of 13.9 times forward earnings. Analyst estimates call for a forward growth rate of 9.2%, lower than Costco’s; however, not so low as to warrant such a discrepancy in valuation.
Additionally, Wal-Mart Stores, Inc. (NYSE:WMT) seems to be a much more shareholder-friendly company in terms of both dividends and buybacks. The current dividend yield is 2.53% and this has been raised consistently since the company began paying dividends in 1973. Additionally, Wal-Mart Stores, Inc. (NYSE:WMT) has a great buyback program, and in the past five years, the amount of outstanding shares has been reduced by 15.3%, compared to just a 1.8% reduction for Costco over that same time period.
Another alternative, especially if you believe the economic recovery will continue for several years, is Target Corporation (NYSE:TGT), which is a slightly more upscale giant discount chain. Target may actually be the fastest-growing of the three companies mentioned here, with an aggressive expansion plan into Canada underway right now. In fact, in 2013 alone, over 125 new Target stores are expected to open in Canada alone.
Target trades for 15.1 times earnings, which seems like an absolute bargain when you consider that a forward growth rate of over 15% is projected for the foreseeable future. Target pays a dividend of just over 2%, making this a true growth/income play, and my current favorite of the three.
Final Thoughts about Costco
While I love Costco as a company, and shop there frequently, there are simply better options right now for both growth and income investors. One interesting thing I’d like to share that I found when researching Costco Wholesale Corporation (NASDAQ:COST), however, could turn the tables very quickly.
Those who have been following political news recently knows that President Obama has called for raising the federal minimum wage to $10.10 per hour, which you may think would be bad for all retailers of this nature. What I didn’t realize was that Costco’s average sales associate makes $11.56 per hour, more than $2 per hour more than Wal-Mart Stores, Inc. (NYSE:WMT) or Target. So, the minimum wage hike wouldn’t really affect Costco Wholesale Corporation (NASDAQ:COST) much, if it happens, and it could be a game-changer for the profitability of the other two companies.
The article This Discount Giant Is Too Expensive, But There Are Better Alternatives originally appeared on Fool.com and is written by Matthew Frankel.
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