Husslein: COST Earnings Strong, Outlook Faces Potential Disruption

0:00KOSCO reported its quarterly results after the close yesterday beating expectations on both the top and bottom line to discuss the report we want to bring in and Brett who's flying equity analyst consumer equity research at Morningstar. Brett thank you so much for joining us today. So listen, KOSCO beat expectations. EPS 450A revenue coming at 69.6 billion. Same store sales comps of 7.4 percent. Looks like solid numbers. The stock little changed this morning honestly and look broad broad speaking in the market will probably take another leg down today. But Brett, what's your reaction to its results? Hey Diane, thanks for having me on. Yeah, so KOSCO obviously continuing their consistent level of excellent performance. Truly just doing a great job as far as growing membership growth. They grew pricing by 9 percent pretty much fueled by membership upgrades their executive tier. Another 5% on top of that just a sheer number of volume of new members. So bringing it all together

1:01is about 14% quarter of a quarter for a year of a year membership growth. On top of that, it's just truly just great execution as far as navigating the entire tariff environment and all sorts of geopolitical volatility and it's the winter weather storm that took place as well. They're just seeing consistent traffic consistent to take a gains on top of that too. Does that mean that you all would be looking at changing your fair value estimates because ahead of the report your fair value estimate saw the stock at 650. Does this most recent quarter mean that you know you would take another look at this one? Yeah, Diane, that's a great question. So the way we value things in Morningstar is pretty much we take a long-term approach here. We're looking at trying to value the business intrinsically. We're not really trying to look at where the company is going to trade in the next 12 months or so. So pretty much right now I think as far as like maybe the multiple that's assigned to my my fair value estimate of about $650 which we plan to raise a bit by a low single digit percentage after this quarter. It's sounding about a 33-34 times

2:04forward earnings multiple to it. Now Costco is trading at about 45-50 times forward earnings multiple right now. They've seen over the course the past few years at quite a fair amount of multiple expansion there but long story short we plan to hold a reasonable a reasonable level here at about $650. We're pricing in over a hundred basis points of operating margin expansion over the course the next decade. This is paired with with a high mid-high single digit revenue growth as well. This is just really what we look to see as a kind of like a mid-cycle. We're trying to value this company at like a kind of like a mid-cycle earnings level. So like not like and they're best year and on their worst year year. So we're trying to really just hold this. This is obviously a one-year view. I see a lot of analysts and listen I know you know you don't have to go with the herd raising their price targets on Costco and it seems to me the case seems to be there at least based on this most recent quarter what the indications are from here. So how do you think about then the tax refunds

3:07because there are some who view the tax refunds this year that are expected to hit consumer households as beneficial to Costco. What's your thought on that? Yeah I mean there's I think if they've got strong momentum going their way right now and they are starting to see I guess a bit of growth moderate just a tablet as far as like new membership growth as they're already established in so many markets there's really I don't think I think management noted that there's not necessarily a whole lot of I guess new completely new markets that they've entered recently and they're you know trying to work on that and trying to innovate there as far as how they can go about that such as like downtown LA now as far as seeing a a windfall from I guess maybe like these tax refunds yeah that could definitely hit them that could hit a bunch of these other retailers especially those that I guess a bit are a bit more discretionary oriented as well so maybe we see Costco's general merchandise sales take up a bit and maybe we see some new new members there and then we see across a broader set of retailers that maybe are just a bit more discretionary

4:08focus this could potentially also possibly impact the target as well. Okay and then let me ask you this about your note you said you believe that Costco's expanding profitability and membership loyalty reinforces its wide mode so do you expect to see a continuation of the increases in retention of members. Yeah absolutely we definitely we definitely plan to see an increase in their retention of members now in the short term I think over the last two quarters we've seen about a 20 basis points of dip from in their US and Canada renewal rate. Now they they largely attribute that to their their new younger members really being more digitally acquired rather than signing up in the store and they've really been putting forward a lot of effort as far as retention efforts to mitigate that I guess that loss where there's these younger members I guess are renewing at a lower rate but I think over the midterm I think we may

5:08see this for next few quarters but over the midterm mid to long-term I see Costco really just building out there their expertise there and really holding on to these these new younger digitally acquired members. So then to go back to your point in terms of where you see value and Costco from here since you even with you planning to raise it it will be quite some distance from where it is now. What's the risk that you see is if the competitive landscape what concerns you? Sure absolutely the competitive landscape I think it's really maintaining this a degree of growth that the market is really pricing in I mean the market's pricing in high level high EPS growth and I'm pretty sure as far as our our valuation goes like we we're repressing in low teens EPS growth compounded over the next of course the next decade it would really require this to not have a slowdown or really really pause in the momentum or the consistency over the course of over the course the next decade here to really justify the current valuation that's trading at and I think that's really I think I could lead to a risk of potential multiple compression or yeah if there's

6:10any sort of slowdown there I guess. How do you think it stacks up compared to Walmart? We're talking about two exceptional retailers here as far as consistency goes now Costco has traded at a pretty exceptional multiple for quite some time now for quite a few years I think like maybe like five years ago four or five years ago I think they're a little closer I guess I guess the way we would I guess my valuation as far as about 33 35 times there. Now Walmart on their hand they've really expanded of the course of the last year as far as their multiple goes is about doubled I mean their historically trade about 2025 times earnings over the course these last five years now they're trading at they're also trading about 45 50 times earnings as well market is really tripping a whole lot of growth there and a whole lot of consumer trade down which we're not necessarily sure we'll translate into a all-time high profitability for them which is really what the market is pricing in for Walmart as well they're really kind of price of perfection there. All right Brett thank you so much that's Brett Hustlain equity analyst consumer

7:15equity research at Morningstar thank you Brett.