Costco Still Looks Like the Leader

The allure of buying in bulk has kept sales and profits afloat at warehouse clubs. But how long will investors keep buying these stocks?

Both Costco (COST Quote) and BJ's Wholesale Clubs (BJ Quote) reported rising profits Tuesday, providing more evidence that deep discounting -- even if it means buying the gallon-sized mayonnaise -- is the way to consumers' hearts.

But investors' penchant for concentrating their money on the leaders in various retail subsectors has created some highly valued stocks, worrying some observers that the upside for some big retail names is limited. Early afternoon Tuesday, shares in Costco were down 54 cents at $40.45, while BJ's stock was up 49 cents at $42.39.

The warehouse retailers' reports came as retail stocks were down across the board in the wake of a sector downgrade from Credit Suisse First Boston, which lowered the sector to underperform, on valuation and earnings worries. The S&P Retail Index was off 2.8% around midday.

Sticking With It

In their conference calls, both companies reaffirmed financial guidance. BJ's said it was comfortable with the current range of 2002 earnings estimates of between $2.24 and $2.28 a share. Costco, meanwhile, was cautious, but nevertheless endorsed the current consensus estimates for the third and fourth quarters of 28 cents and 50 cents a share, respectively.

"We felt that those numbers are at the high end of our range, but we've met that in the past and we'll see where we come out," said Richard Galanti, Costco's chief financial officer, in the conference call.

As recession set in last year, investors and Wall Street began chirping that warehouse clubs were in a good position to stake out solid results, especially during the holiday season. While in holidays past, warehouse clubs were hardly a holiday gift-giving destination, this past year a widening assortment of goods -- such as electronics -- attracted would-be Santas, although not to the degree that some may have been hoping for.

"I think they met, but didn't exceed, expectations," says Todd Slater, an analyst at Lazard Freres who covers both companies. (He has a hold rating on both stocks, and his firm doesn't have a banking relationship with the companies.)

"I think they're both reasonable opportunities, but just not the 20% upside potential in the near term, which is needed for a buy recommendation," he says.

Neck and Neck

Slater notes that Costco continues to widen the gap on a same-store sales basis with BJ's. From September 2000 to September 2001, BJ's typically lagged Costco by just 40 basis points, he says, much smaller than the gap of nearly 400 basis points in the recent quarter. Wal-Mart's Sam's Club division, the other competitor in the warehouse sector, reported a 5.7% comparable-store increase in its latest quarter.

Investors seem to acknowledge as much: Since stocks bottomed in the wake of Sept. 11, Costco shares are up about 29%, while BJ's stock has risen just 8%.

Even as the leaders of various sectors continue to post strong financials, investors have come to worry about valuation lately. Costco, for example, trades at more than 24 times forward earnings, a premium to its estimated annual growth rate of 15%. Others, such as drugstore chain Walgreens (WAG Quote) and consumer electronics giant Best Buy (BBY Quote), have also chalked up premium valuations, in part because of their strong performance.

Yet with competitors faltering lately, investors may be willing to pay up as long as the earnings keep rolling in.