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Costco Down 14% in 3 Months: What's Bothering the Retailer?

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Shares of Costco Wholesale Corporation (COST - Free Report) have fallen over 14.3% in the past three months and also underperformed the industry that declined 5.9%. This fact alone is enough to unnerve investors. But what is bothering 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 9.5% clearly indicate the stock’s inherent potential. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Why is the Stock Struggling?

Shares of Costco were hit hard and plunged almost 7.2% on Jun 16, after the news of Whole Foods Market, Inc.’s buyout by Inc. (AMZN - Free Report) 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.

The transaction, which is likely to conclude today, recently got approval from Federal Trade Commission. 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. The buyout of Whole Foods will give Amazon an easy access to roughly 460 stores in the United States, Canada and U.K. and also a foothold in the grocery business.

It is likely that Amazon may try to be more aggressive on prices. This may hurt the market share of Costco which is reliant on store-based model to a large extent and faces stiff competition from Wal-Mart Stores Inc. (WMT - Free Report) .

Is 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 United States, 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 July increased 6.2%, following an increase of 6% in June, 4.1% in May, 3% in April, 6% in March, 4% in February and 7% in January. Notably, net sales increased 8.8%, 7%, 7%, 5%, 9%, 8% and 9% in July, June, 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. Further, it plans to open nearly 26 net new outlets in fiscal 2017, of which approximately 13 are expected to be opened in the United States 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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