Why Costco stock could power higher next year, according to an analyst

Jefferies Analyst Corey Tarlowe joins Yahoo Finance Live to discuss Costco earnings, inflation, club growth amid rising membership fees, gas demand, and the outlook for Costco.

Video transcript

- Costco was out with a rare earnings miss, though the retail giant is pointing to improvements in supply chain and inflation. Joining us now to discuss is Corey Tarlowe, Jefferies Equity Analyst. Corey, good to see you here. You're staying with a buy rating, I believe, on this stock. Make your case.

COREY TARLOWE: Yeah, Brian. That's correct. So I think that with good merit, you made Costco the 2022 company of the year, and for one very simple reason. And it's that when it rains on everybody else, it only really drizzles on Costco.

So number one, inflation is starting to improve. And so for the first 10 months or 11 months of this year, I guess, inflation was closer to about an 8% level. And now it's starting to come down to a 6% or 7% level, according to the CFO Richard Galante. So that's number one.

What does that mean? Well, while it's helped drive higher sales, it means that costs might not be up as much as we look ahead and that could potentially drive better margins. Number two, supply chain continues to improve.

So we've heard a lot of companies talk about freight rates coming down. Costco is one of the main importers. It's the third largest retailer in the world, so it's going to benefit from that to a very meaningful degree.

Third, higher-tier memberships continue to grow. Private label penetration continues to be up and I think ahead of what it usually grows at at a historical rate. So right now, I think it's probably closer to a mid to high 20s percent penetration, and that continues to trend upward. It's the Kirkland Signature brand that a lot of us know and love, and it's continuing to grow. It's higher margin, as well, so it boosts profitability.

And then the renewal rates continue to be really strong. So Costco's renewal rates worldwide are about 92%, 90% on a US and worldwide basis, respectively. So all those things tend to bode pretty well for Costco as we look ahead.

As far as what we didn't like, things to highlight in the quarter, well, obviously, consumers are pressured. And bigger-ticket item purchases are weighing a little bit, particularly in the E-COM channel. But what we do like is that the company is investing in pricing to help people save money in areas like food.

So that's helping to drive a little bit-- or that's driving a little bit of margin pressure near-term. But nonetheless, it's helping to drive higher traffic, which is really important. So more people are going into the door. But it is degrading margins just a little bit near-term as they continue to invest in price to drive share gains.

- So Corey, if what you're describing, the sort of solid story here, but at the same time, some signs of weakness at the margins, including on those big ticket items that you talked about, a lot of your peers on the street are cutting their price targets this morning, even those that also have buy equivalent ratings. I believe you still got 610, if I'm not mistaken. That's a big lift over the next year, right? How achievable do you think that is?

COREY TARLOWE: I think it's pretty realistic, as we look to the fundamentals of this business. It may not be a linear path up but it is one that we see continued growth in this stock. And like I said, I think that Yahoo! Finance made Costco the 2022 company of the year with good merit and for good reason.

And we see a lot of the same positives that you guys see on your side. So with regards to the numbers, well, you have inflation coming down, so that should help to support better numbers. You have membership continuing to rise, and then you have continued club growth to underpin top line sales expansion.

So a lot of the fundamental drivers of Costco that we see and like about the story, we see that continuing into next year. And that should continue to drive higher numbers, as well as a higher stock price.

- Corey, we just picked Costco because of the hot dogs. I mean, they taste great, and they're $1.50 with the free soda refills. No, but really, on that call last night, Richard Galante, the CFO, we've all talked to him before.

And he told me when we interviewed him a week ago for this package and for this company of the year award, they're not going to probably push through a membership fee increase maybe over the next quarter or two. When do you see that happening? Is that going to happen next year? Because if it does, that is a major profit tailwind for this company.

COREY TARLOWE: Yeah, I think to your point, it's not "if." And I think about a year ago, Costco's CEO Craig Jelinek had said that it just wasn't the right time because inflation's running again in the high single digits, gas prices are above $3 a gallon, and the consumer's pressured. So doing something like that would be off color.

But Costco does typically tend to raise the prices on its membership about every 5 years and 7 months. The last price increase was in June of 2017. So if you extrapolate that out, you're looking at sometime early next year that it could occur, or it would occur based on that 5 year and 7 months interval.

It may be a little bit longer than that. The board, I believe, meets in January. It meets once a quarter. So we'll know when they've decided upon whether or not when they will raise the rate. It will come at some point. We just don't necessarily know when.

But we did do the math to estimate what it could do to earnings, and we believe that it could drive a low to mid-single digit EPS lift over the next two years once that price increase is instituted, and that is not currently in consensus estimates at this time.

- Corey, good to catch up with you on Costco. Thanks so much. Appreciate it.