Costco Wholesale Corp. (NASDAQ:COST) produced solid quarterly results on March 3, 2022, showing good financial results for the quarter ending Feb. 13. As a result, expect to see COST stock continue the slow rebound it has been making recently.
COST stock has been recovering from its trough price of $477.32 which it hit on Jan. 25. As of Monday, March 7, it had moved up to $533.55
But this is still lower than where it ended the year in 2021 as COST stock ended last year at $567.70 on Dec. 31. So, year-t0-date (YTD) it’s still down 6.14%. It now seems probable that the stock will continue its rise. Let’s look into this further.
Where Things Stand With Costco
Last month I discussed Costco’s monthly sales growth progress. January sales (ended Jan. 30) showed an increase of 15.5% YoY. This was after December sales (ending Jan. 2) rose 16.7% year-over-year (YoY). With the latest results, February sales results came in at 15.9% higher for the month ending Feb. 27.
The quarter ending Feb. 13 produced 14.4% higher sales than a year ago. Costco indicated that its net income rose 36.6% to $1.299 billion, up from $951 million. Moreover, EPS rose 36.4% to $2.92 per share.
So far Costco has not produced its 10-Q filing for the quarter, so we do not have any Cash Flow Statement. We do not know yet what the company’s free cash flow (FCF) was for the quarter ending Feb. 13. This was excluded in the original press release for some reason. I suspect it has to do with balance sheet issues and how the capital expenditures were made during the quarter.
Nevertheless, last quarter the company made an FCF margin of 4.37%. If we apply this margin to analysts’ projections for 2022 sales, we can estimate its full-year FCF.
For example, 26 analysts surveyed by Seeking Alpha predict that sales for the year ending Aug. 31, 2022, will be $219.57 billion. Applying a 4.37% FCF margin means we can predict that Costco will make almost $10 billion in FCF ($9.69 billion).
As a result, we can use this to derive a new value for COST stock.
What COST Stock Could Be Worth
Here is how that could work out. If we divide $10 billion by a 3% FCF yield, which is the same as multiplying it by 33.3 times, the target market value is $333.3 billion (i.e., $10b x 33.33 = $333.3b).
This is about $100 billion or so higher than Costco’s present $236.3 billion market cap. It implies that COST stock should be 41% higher (i.e., $333.33b/$236.3b-1=0.41).
In other words, COST stock is probably worth somewhere around $741 per share. But that would be higher than where the stock has ever traded. To be even more conservative, let’s assume that the market gives the company a 4% FCF yield. That is the same as a P/FCF multiple of 25 times.
This gives the stock a $250 billion market cap target value, which is 5.8% over today’s price. In other words, just a slight change in the valuation of Costco’s free cash flow results in a huge change in its valuation. The average of these two multiples is 29.16x.
That puts the stock at a $291.6 billion market cap or 23.4% over today’s price. This gives it a target price of $648.47 per share. In other words, depending on the multiple on where COST stock appears significantly undervalued.
What To Do
We could wait for the company to produce its quarterly cash flow statement. But either way, the company is highly likely to be FCF positive. Depending on how high that FCF margin turns out to be could affect the upside valuation for COST stock.
But even before that most value investors will probably start investing on the basis of “buy on the rumor, sell on the news.” In other words, by the time the cash flow statement is published the stock could already reflect much of the upside. This will especially be the case if the cash flow statement is better than expected.
Either way, COST stock will probably do well over the coming year, assuming that the U.S. does not enter into a recession or consumer spending does not slow down.
On the date of publication, Mark Hake did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.