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Costco Wholesale Corporation Stock Isn’t Cheap Enough, Yet

Laura Hoy

The retail apocalypse is upon us. Worries about the future are the primary reason that warehouse wholesaler Costco Wholesale Corporation (NASDAQ:COST) has seen its shares sink 12% since June. Department stores are sinking quickly, and many predict that grocers, including Costco stock, are next in line to be slaughtered. Amazon.com, Inc. (NASDAQ:AMZN) tore through the retail sector over the past decade, and now the e-commerce giant is fixing its sights on grocers with its acquisition of Whole Foods.

Costco Stock Isn’t Cheap Enough, Yet

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Unlike the many naysayers, I don’t think Amazon’s entry into food will be quite as detrimental to grocers as it was to department stores, but that doesn’t mean it won’t affect them at all. The industry is likely to face some turbulence over the next year or more as investors evaluate whether or not grocers are able to change with the times.

The uncertainty in the grocery space has been providing opportunities to pick up good-quality companies for a discounted price, but unfortunately Costco stock isn’t one of those bargains. Not yet, anyway.

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Costco Stock Earnings Strong

I don’t think COST stock is going to go down in flames. One look at the most recent Costco earnings report can tell you as much. Comparable sales were up an impressive 6.2% from the same time last year, and the firm was able to grow its revenue by 15.8%. Compare that to rival Wal-Mart Stores Inc. (NYSE:WMT), whose revenue only increased by 2.1% from the previous year, and you can see that Costco is performing.

Those are some pretty impressive results, especially for a retailer whose primary business is brick-and-mortar and that depends on store traffic. However, following the release, Costco stock price actually declined as investors absorbed the potential impacts of the Amazon/Whole foods partnership and worried about whether customer loyalty can continue.

The Problems for Costco Stock

The way I see it, there are three factors dragging down Costco stock. First, there’s the firm’s business model and the fact that it doesn’t translate well into an online experience. Despite the fact that the company reported a 30% increase in online sales during its last earnings report, investors are worried about Costco’s online presence. Those worries are legitimate because a huge draw for customers is the in-store “treasure hunt” experience. The firm also relies on customers stocking up and buying in bulk when they visit the store, something they’re unlikely to do while shopping online.

Second there’s customer loyalty. On one hand, Costco can rely on membership fees to pad its revenue and increase margins. But on the other hand, there’s the question of how many memberships customers are willing to hold. Fellow InvestorPlace contributor Brent Kennel touched on this earlier this month and wrote that in 2013, 14% of members exclusively belonged to Costco, but that figure fell to just 8% this year. During the same period, the percentage of Costco members who also had an Amazon Prime membership rose from 28% to 64%. That’s a worrying trend if you believe that people won’t want to pay membership dues all over town.

Finally, and probably most importantly, is that Costco doesn’t have much wiggle room to wage a price war against its competitors. Costco has an operating margin of just 3.19%. That’s a problem because the firm may eventually need to cut membership fees or reduce prices in order to retain customers.

Not Yet Time to Buy Costco Stock

I think Costco will prove to be a lasting player in the grocery space. The company runs a unique business that is likely to continue drawing customers. Once the firm sorts out a compelling online strategy, I think investors will gain confidence in the stock. However, I don’t see COST stock taking off any time soon, and that’s why I’d wait to buy it. Costco is still expensive trading at 26 times its earnings, and the stock likely has further to fall.

As we saw when the firm released its earnings, Costco stock is going to be weighed down by worries about the sector as a whole, no matter how the company is performing. Unfortunately for investors, Costco news isn’t the only thing affecting the share price. COST stock is also moving on news from competitors and wider concerns about the grocery business in general. At the moment, I don’t think it’s cheap enough to be considered a value play, and the Costco stock dividend yield of 1.26% doesn’t do much to inspire income investors. For now, it’s worth waiting on the sidelines.

As of this writing, Laura Hoy was long AMZN.

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