Costco Wholesale Corporation (COST): This Retailer’s Expensive Valuation Is Warranted!

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There’s no doubt that warehouse club operator Costco Wholesale Corporation (NASDAQ:COST) has turned in a solid performance so far this year with a gain of around 16%. The stock trades close to its 52-week high and trades at a rich valuation, which might create some doubts in the minds of investors whether Costco Wholesale Corporation (NASDAQ:COST) can keep chugging like it has done so far.

Costco Wholesale Corporation (NASDAQ:COST)

Costco trades at 24 times trailing earnings, and the ratio drops to 22 on a forward basis. The PEG ratio isn’t that handsome either at 1.81. Moreover, the company isn’t expected to grow at a rapid rate that justifies such a valuation, with analysts expecting revenue to grow 6.6% this year and 8.7% in 2014. Similarly, earnings are expected to rise 15% this year and 11% next year.

Also, the stock won’t lead you to overnight gains, as evidenced by a gain of 23% over the past year which many might consider pretty low given the high fliers we see nowadays. However, that’s the catch about Costco Wholesale Corporation (NASDAQ:COST). It’s been a stable performer and certainly deserves a place in one’s portfolio as it will go about doing its job silently and it also pays dividends (both regular and special), making for a really good combination.

Business model par excellence

Throw in a solid business model which ensures that customers keep coming back to its warehouses and with a lot of opportunity to expand, I believe Costco Wholesale Corporation (NASDAQ:COST) deserves its premium valuation and can prove to be a solid investment even at these levels.

Membership fees are a crucial part of Costco’s business strategy, not only because they bring in revenue and pump up margins, but also because they are a solid indicator of the strength of the Costco brand. For instance, the company witnessed a 12% jump in membership fees in the previous quarter to $531 million and new member signings jumped an impressive 19% from the year-ago period. The growth in fee income and members, despite fee hikes, suggests that consumers swear by what Costco offers.

As Fool analyst Andrew Marder pointed out, Costco Wholesale Corporation (NASDAQ:COST) has added 1.6 million members in the first two quarters this year, and more importantly, membership renewal rates continued to be strong. Renewal rates stayed strong at 93.9 in the previous quarter, which suggests the stickiness of the brand.

Expansion ahead

International expansion played an important part in the rise of Costco’s membership base as warehouse openings in Japan drove up the count. Costco has a lot of room to flex its muscles, both internationally and domestically. The company had 627 warehouses at the end of the previous quarter, out of which 448 were in the U.S. and Puerto Rico, 85 in Canada, 33 in Mexico, and other spread across the U.K., Japan, Taiwan, Korea, and Australia.

The company is aggressively opening more warehouses and is looking at square footage growth of 4.5% this year, up from last year’s 3%. This is certainly impressive, and given the fact that Costco Wholesale Corporation (NASDAQ:COST) is still going to open almost half of the expected 28 stores this year in the U.S. and three in Canada, it means that there is still room to grow in the North American market. Thus, it’s clear that Costco is still not moving aggressively in international markets and once it does so, there would probably be further room to run.

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