- Costco has endured a difficult year in 2015 as low gas prices and a string dollar decimated growth and earnings.
- These headwinds are expected to remain largely unchanged in 2016.
- Is Costco stock worth holding in 2016?
Giant warehouse retailer Costco (NASDAQ:COST) is looking to finish the year in style. After enduring a torrid year where its sales numbers were pressured by FX headwinds and ultra-low gas prices, Costco posted impressive sales numbers for the month of November that triggered a major upgrade on Wall Street. Costco net sales increased 3% on year to $9.68B in the month of November. Excluding the effects of low gas prices and currency swings, Costco sales in the U.S. grew +6%; +8% in Canada and +7% in Other International markets.
The strong results led to an upgrade by Deutsche Bank, which noted that Costco’s growth far outpaced that by other major retailers such as Walmart (NYSE:WMT) and Target (NYSE:TGT). DB upgraded Costco from Hold to Buy with a hefty $200 price target (20% upside), noting that the company’s organic food growth, improving gas prices, and the credit partnership with Visa as major catalysts. DB also dubbed Costco as being ‘Amazon Proof,’ which is not a very easy tag to land in the retail sector.
After starting the year badly, Costco stock has rallied strongly during the tail-end of the year and currently sport an YTD return of 21.8% vs. 13.1% by the Consumer Discret Select Sector SPDR ETF (NYSEMKT:XLY).
Costco stock vs. Consumer Discretionary Select Sector SPDR ETF (XLY) YTD Returns
Costco in 2016
Retail analysts assign the ‘Amazon Proof’ tab to retailers with an unusual business model that makes them almost invulnerable to Amazon. In the case of Costco, it’s low margin merchandise and bulk selling model makes the company stands out. Costco marks up its goods by just 15% compared to 25% or more for the average big box retailer.
Coscto also constantly changes the variety of goods in its stores such that customers never know what to expect when they visit the store next time. This makes up for an exciting treasure hunt experience that keeps customers coming back. Costco’s business model has been tried and tested, and is one of the most enduring in the retail world due to its ability to perform well regardless of the economic cycle.
But the big question now is how Costco is likely to perform in 2016 with the ongoing challenges of low gas prices and a strong dollar. Costco started selling gas back in 1995 as a way to retains its customers. Costco sells gas about 6 cents to 12 cents cheaper than market prices. The strategy has proven to be pretty effective for the company as evidenced by its industry-leading 91% customer retention rate.
But low oil prices have been hurting Costco’s bottom line, and are one of the key reasons why the company’s earnings have been under pressure in 2015. Costco earnings have grown just 2.75% in 2015, compared to 15.48% in 2014.
Oil prices recently dropped to a 10-year low. But just how low can gas prices go? According to the U.S. Energy Information Administration (EIA), gas prices in 2016 might even be lower than they were in 2015, averaging just $2.38 per gallon.
Record crude production in Texas as well as hydraulic fracturing are mainly to blame for the oil glut. Texas accounts for 35% of the country’s crude supply, and the state is awash in cheap oil.
Not everybody, however, holds this bear view on oil. The World Bank predicts that Brent Crude in 2016 will average $47.70, or almost 25% higher than current prices, then slowly increase to $56.90 by 2020. OPEC and banks on Wall Street are also optimistic that oil prices will be higher in 2016 than they were in 2015. The gas bulls point to reduced capex on production and exploration in 2015 as the reason why production in 2016 will be depressed resulting in higher prices.
While there is some hope for a recovery in oil prices, the same cannot be said for the U.S. Dollar. The American economy happens to be doing comparatively better than most other major world economies, and this is not likely to change soon. The U.S. dollar is expected to continue strengthening against a basket of most major currencies including the Euro and British Pound. This is not good news for Costco which has one-third of its 686 warehouses located outside the U.S. Moreover a good number of the new stores that the company plans to open in 2016 will be in foreign markets.
Costco investors should therefore expect more of the same in 2016, with subdued oil prices and currency headwinds continuing to wreak havoc on Costco’s bottom line. But all is not lost. 2015 has mostly been a difficult year for the company, which automatically sets up easier comps for 2016. So comparative growth in the coming year should improve somewhat. Analysts project that Costco’s earnings will average 8.90% CAGR over the next five years.
Costco stock can, therefore, still make sizable gains in 2016 and over the long-term. This makes the stock good for the long haul.