The Wrong Time to Buy in Bulk

 | Dec 13, 2011 | 8:00 AM EST
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Last week Costco (COST) reported its fiscal first quarter (ended Nov. 20), and the results disappointed some investors, as two large one-time items totaling $0.07 hit its earnings per share. The stock declined sharply, and some thought it was a buying opportunity -- but I'm not among them.

Yes, same-store sales were strong: Excluding gasoline and foreign currency, comps were up a total of 7%, including 6% in the U.S. and 11% internationally. However, I was disturbed by the weak gross margins, which came in at 10.62% -- 35 basis points lower than last year. While 35 basis points is not a big deal, other warehouse retailers have also experienced gross-margin declines. Wal-Mart (WMT) subsidiary Sam's Club, for instance, saw its gross margins fall 28 basis points. It was the first time in 12 quarters that this number slipped.

Costco management cited inflation in fresh food and higher expenses. For example, fresh-food inflation was anywhere between 5% and 8%, especially on meat and poultry. Blueberry prices were up 60% and grapes rose 20% year over year.

I believe the weakness in gross margin can be attributed to the fierce competitive environment, and I'm concerned investors are expecting too much growth out of Costco. In the last three years, revenues only grew at an annualized 7%, mostly driven by new store openings, increased membership sales and higher gasoline prices. Over that time, net income grew at just a 4% annualized rate.

At the current quote, Costco trades around 22x fiscal 2013 estimates of $3.88. Aggressive stock buybacks are boosting earnings per share. Most analysts are projecting a 10% to 12% increase in revenue and an 18% increase in EPS. If you want to buy in bulk, it seems to me that a more reasonable price for Costco is in mid-to-low-$70s, or around 15x to 18x estimates.

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