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Costco Wholesale Corporation (COST): Should You Pay a Premium for This Retail Stock?

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Costco Wholesale Corporation (NASDAQ:COST)There is a certain feel good factor about Costco Wholesale Corporation (NASDAQ:COST), the largest warehouse retail club in the U.S. Shoppers are happy with the excellent bargains that they are able to fish out and the employees are happy with their paychecks and benefits. But, what about the investors? Can they, too, join the party and feel good about the prospects of the stock? Let’s find out.

Position vis-à-vis other retailers

We find that out of the big discount retailers, Costco Wholesale Corporation (NASDAQ:COST) commands a premium valuation. It is trading at a forward P/E of 21.96 times, which is close to double that of Wal-Mart Stores, Inc. (NYSE:WMT)’s 12.85 times and Target Corporation (NYSE:TGT)’s 12.71 times.

But, Costco Wholesale Corporation (NASDAQ:COST) justifies this premium adequately through unmatched strength in its core operating fundamentals. An immediate example can be the performance of these three giant retailers in their recent quarters.

In a quarter where weather woes got the better of most retailers, Costco Wholesale Corporation (NASDAQ:COST)’s performance was impressive, to say the least. Excluding gasoline and foreign currency fluctuations, the company generated comparative sales growth of 7% in its U.S. operations.

In comparison, Wal-Mart Stores, Inc. (NYSE:WMT)’s U.S. comps were down 1.4% and Sam’s Club, the warehouse division, was essentially flat at 0.2%. Target Corporation (NYSE:TGT), too, reported a 0.6% decline in same store sales in the U.S. retail segment.

Analyst expectations

For the full year, analysts expect both Wal-Mart Stores, Inc. (NYSE:WMT) and Target Corporation (NYSE:TGT) to report modest revenue growth compared to last year. The former is expected to increase its revenue by 3.8% to $469.2 billion, while the latter is expected to generate about a 2.2% increase to $74.9 billion.

In terms of earnings, Wal-Mart Stores, Inc. (NYSE:WMT) is expected to grow its earnings per share by 6% from $5.02 to $5.30. Its performance will benefit from the lack of headwinds like weather and delayed tax refunds, which affected first quarter results. Also, Target Corporation (NYSE:TGT)is expected to earn $4.36 per share, just below its last year’s earnings of $4.38 per share.

But, analysts expect Costco Wholesale Corporation (NASDAQ:COST) to grow its revenue by 6.7% to $105.8 billion and its earnings per share by 15% to $4.56 per share. The optimism about the company stems from key factors like its rising member base, fast growing ancillary services business, and, above all, superior customer satisfaction track record, which will continue to increase its popularity and fuel growth.

Growing membership count

Millions of shoppers are signing up for Costco Wholesale Corporation (NASDAQ:COST) memberships each year. The company witnessed 19% y-o-y increase in new signups in the third quarter, and ended up with 69.9 million cardholders. It enjoys a strong 89.9% renewal rate in the U.S. and Canada, and this comes despite a 10% fee increase that Costco implemented in November 2011 for new members and in January 2012 for renewals.

The company is seeing an increase in the proportion of executive members. The executive members pay $110 membership fees, which is double the $55, paid by ordinary members, to earn 2% annual rewards on their shopping. The proportion of executive members stood at one-third the total membership base at the end of the third quarter.

In addition to the obvious direct gains, there is an added advantage for the increasing proportion of executive members. When people pay hefty amounts as membership fees, they like to extract the maximum benefits. So, they tend to shop more. Costco Wholesale Corporation (NASDAQ:COST) saw a 5.5% increase in shopping frequency during the third quarter.

Customer satisfaction

The growing number of new members, increase in shopping frequency, and solid comps growth all tell one story, and that’s of satisfied customers.

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