Costco Down 10% in One Month but All's Well with the Stock

Shares of Costco Wholesale Corporation COST are down over 10% in the past one month, and this fact alone is enough to unnerve investors. But what suddenly went wrong with this Zacks Rank #3 (Hold) stock, which otherwise looks quite sound fundamentally. Further a VGM Score of "A" and long-term earnings per share growth rate of 9.7% clearly indicates the stock's inherent potential.

What Hurt the Stock?

Shares of Costco were hit hard and plunged almost 7.2% on Jun 16, after the news of Whole Foods Market, Inc.'s WFM buyout by Amazon.com Inc. AMZN surfaced. The e-commerce giant entered into an agreement to acquire Whole Foods for $42 per share in an all-cash deal valued at roughly $13.7 billion, including net debt.

Among other stocks who felt the pinch were Wal-Mart Stores Inc. WMT, Target Corporation TGT and The Kroger Co. KR. The impact of this was clearly visible in the Zacks categorized Retail-Discount & Variety industry that declined roughly 8.2% in the past one month.

The deal could provide Whole Foods a competitive edge. At one end it will allow the company to reach a wider customer base that prefer shopping online, while on the other end it will help lower procurement costs, given Amazon's huge bargaining power. Not to forget, Amazon's technological prowess could be of significant advantage to Whole Foods against its peers – who are aggressively expanding online presence – and could help lower operating costs.

Costco Fundamentally Sound

Costco continues to be one of the dominant retail wholesalers based on the breadth and quality of merchandise offered. The company's strategy to sell products at heavily discounted prices has helped it to remain on growth track as cash-strapped customers continue to reckon Costco as a viable option for low-cost necessities.

We believe that the company's recent hike in annual membership fees and increased penetration of Citi Visa co-brand card program will also benefit the stock in the near term. We are also encouraged by Costco's expansion strategy, as it remains committed to opening new clubs and expanding e-commerce capabilities. The company is also gradually expanding its e-commerce capabilities in the U.S., Canada, U.K., Mexico, Korea and Taiwan.

Costco continued with positive comparable-store sales (comps) performance driven by improved store traffic and average transaction size. Comps for May increased 4.1%, following an increase of 3% in April, 6% in March, 4% in February and 7% in January. Notably, net sales increased 7%, 5% 9%, 8% and 9% in May, April, March, February and January, respectively.

We are encouraged by the company's expansion strategy. Costco opened 23 and 29 net new outlets in fiscal 2015 and 2016, respectively, and plans to open nearly 26 net new outlets in fiscal 2017, of which approximately 13 are expected to be opened in the U.S. with the remaining in international markets. In our view, the company's diversification strategy is a natural hedge against risks that may arise in specific markets.

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