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Costco Reaffirmed at Neutral

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We reaffirm our long-term Neutral recommendation on Costco Wholesale Corporation (COST - Free Report) with a target price of $124.00, as risk and reward balances itself.

Why the Reiteration?

Costco continues to be a dominant retail wholesaler based on the breadth and quality of merchandises it offers. The company’s strategy to sell products at heavily discounted prices has helped it to maintain positive growth amid the beleaguered economic conditions as budget-conscious customers continue to see it as a viable option for low-cost necessities. Having delivered comparable-store sales growth consistently, Costco is well positioned in the warehouse club industry.

Costco delivered comparable-store sales growth of 2% in November, reflecting comparable sales increase of 2% at the U.S. and 1% at the international locations.

We believe that Costco’s differentiated product range enables it to provide an upscale shopping experience to its members, resulting in market share gains and higher sales per square foot. Moreover, it continues to maintain a healthy membership renewal rate.

If we look at Costco’s first-quarter fiscal 2014 performance, earnings came in at 96 cents a share, a penny ahead of the prior-year quarter earnings. The bottom-line improvement was buoyed by top-line growth due to a rise in membership fees and improved sales of discretionary items.

The warehouse retailer’s total revenue, which includes net sales and membership fee, climbed 5.5% to $25,017 million from the prior-year quarter. The revenue growth has accelerated from 0.8% increase witnessed in fourth-quarter fiscal 2013.    

However, both the top and bottom lines missed the Zacks Consensus Estimate of $25,232 million and $1.02 per share, respectively. This Zacks Rank #4 (Sell) stock has delivered negative earnings surprises in the last 3 quarters — 5.9% in first-quarter fiscal 2014, 4.1% in fourth-quarter fiscal 2013 and 1.9% in third-quarter fiscal 2013.

Moreover, Costco faces stiff competition from Target Corp. (TGT - Free Report) and Sam’s Club, a division of Wal-Mart Stores Inc. (WMT - Free Report) , which follows a similar business model that pushes through high volumes of merchandise at low prices in membership-only warehouse clubs. Thus, aggressive pricing to gain market share and drive traffic amid stiff competition may depress sales and margins.

Going by the pulse of the economy, we believe that budget-constrained consumers will remain watchful of their spending and look for discounts. Consequently, we could see more competitive pricing, compelling products and innovative ways to attract shoppers.

Other Stocks Worth Considering

The other better ranked stock worth considering in the retail sector is PriceSmart Inc. (PSMT - Free Report) that carries a Zacks Rank #2 (Buy).

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