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Costco Wholesale is raking in cash. So why isn't the market impressed? Opco propcos we bust through the jargon and a looming government shutdown. Why is the market holding steady? For Monday, September 29th is Blue Markets Daily and I'm Ann Berry. More market details to come. But first senators are meeting right now in Washington D.C. in an attempt to prevent a government shutdown which would otherwise begin at one minute after midnight on Wednesday. Now, any shutdown, which will be the first in seven years, will be the result of an inability of the Republicans and Democrats to pass the bill funding federal services into October and beyond. Now the Republicans control both chambers of Congress, but in the Senate they are short of the 60 votes they need to pass a spending bill. Democrats are calling for an extension of expiring tax credits that they say make health insurance cheaper for millions of Americans and for a reversal of cuts to Medicaid that have been made by President Trump. They also oppose spending cuts to the Centers for Disease Control and National Institutes of Health. Now so far the Trump administration seems to have believed that the Democrats will bear the blame if a shutdown happens and is willing to use a shutdown as the reason to permanently let go of some, quote, non essential workers. So why is the market still holding steady despite what appears to be a tumultuous Washington D.C. well, the current market shrug is actually consistent with history. Since 1976, the US has had more than 20 shutdowns and on average the S&P 500 has dipped slightly during the actual closures, not so much during the run up the actual closures. And since we're not yet in an actual shutdown, the market hasn't yet dropped. And when closures have prompted losses, those have modestly been typically been modest and short lived. For example, during the 16 day shutdown in 2013, the S&P fell less than 3% and then it rallied to finish the year up nearly 30% overall. Investors generally assume that shutdowns are temporary political standoffs and the real concern though is confidence because prolonged uncertainty can rattle consumer spending, delay federal contracts and ultimately weigh on GDP growth. Now, the longest shutdown in U. S History actually happened relatively recently in the last Trump administration and it lasted 34 days. And just to put numbers around the impact of that kind of length of shutdown, Goldman Sachs has estimated that each week of a shutdown shaves about 0.1 to 0.2 percentage points off quarterly growth. Most of that though is often made up with once the government reopens. Still, markets aside, there are real consequences to real people and real businesses. Federal workers go unpaid for the non essential services until back pay is approved. Contractors and small businesses tied to government projects can suffer lasting losses. And markets in recent years have reacted more nervously when shutdown fears collide with debt cells. Ceiling debate that's when we start to get questions about U.S. credit worthiness, about stability. And that's what can shake both equities and treasuries. And so far this year we have in fact seen lukewarm demand for US Treasuries, which is a sign of global concern about the sustainability of the now $2 trillion US fiscal deficit. So we're going to keep watching as that deadline of midnight tomorrow looms to see which moves the market more this federal drama or preparation and frankly, some optimism around the upcoming earnings season. Coming up, we investigate Costco's latest share price moves and Six Flags. What might the theme park player do with all its real estate? But First Brew Markets Daily is sponsored by Public, the investing platform for those who take it seriously. Now, before the show today, our producer John mentioned a feature he recently found on Public that's right, I've been getting.
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Portfolio insights from Alpha Public's AI powered research assistant. Then I discovered Alpha can do recaps of earning calls. That's where I love getting the insights. Peek into a business as soon as.
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It shares its updates, Public gives you smarter context in which to use a wide range of asset classes, offering the tools you need to build and manage your wealth, whether it's with stocks, options, bonds or crypto. So fund your account in minutes or less. Get started at public.com brewmarkets that's public.com/brewmarkets.
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Paid for by Public Investing. Full disclosure and podcast description Costco, the.
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Membership warehouse retailer, released its fourth quarter results on Friday. Friday and we're going to go through the numbers. We're going to go through what is going on with its stock because it's a pretty interesting story once you start to unpack it. But to set the stage, I just wanted to sort of remind everyone of the fact that we all know, but we sort of forget that we know. And that's the fact that Costco is an absolute beast. Its market cap over $400 billion, its share price up over 150% the last five years, and revenue for the last 12 months of 275 billion billion. Now it is tough for companies of that size to keep on growing. And despite the fact that the company did beat revenue and earnings estimates over most recent quarters, not so much on this one. But in the recent past, the market seems to be unimpressed with the pace of its continued growth, which is sort of extraordinary. Now, Costco has a devoted fan base that pays an annual fee for the opportunity to take advantage of the things it's become famous for, a generous return policy, perpetual deals like that $50 hot dog and soda combo and rotisserie chick under $5, which in an inflationary environment and consumers being squeezed, have been part of what's propelled Costco into its popularity. Now, our producer, John is a dedicated Costco member, so give us some of your numbers around here for context.
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Yes, that's right. The store is popular with me. I will say that. And currently Costco has about 900 warehouse stores. It added 27 new locations in the last fiscal year. And they said last Friday that they're looking to add 35 new locations in the coming year. So there is growth on the Horizon. Revenue was $86.2 billion and that beat estimates by $200 million. And earnings per share was 587 compared to 580, which was expected. So they beat on there. But the magic metric for retail, as you like to say, is same store sales growth. And on that, Costco was short. It hit 5.7% growth, but the market was expecting 5.9% growth. And so that's the second consecutive quarter that it missed estimates on same sale.
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So this is what's really important when these earnings coming, John, and you and I talk about it, you can get these headlines which says a company's beat on revenue, beat on earnings. But it's really figuring out what is the core metric that's most important for that industry. And as you just said, same store sales when it comes to retail really is a thing that we're all focused on. Second consecutive quarter here of a miss for Costco. I do just want to chat to you a little bit more about your membership because I'm fascinated by consumer behavior is what drives all this and investing behind what we know has become this sort of saying, right? So you're not alone with your paid membership. There are about 80 million paid membership accounts for Costco. And just one thing, as I was digging through the earnings and I not paid so much attention to this, it's just how global this company is, right? So Costco's got 914 warehouses, about 630 in the US and Puerto Rico, 14 are in Taiwan. Did you know that? 20 are in Korea, 29 are in the UK, 37 in Japan, 42 in Mexico. I mean, it really has a much more global footprint than I'd originally paid attention to.
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That's right. And huge fans of Costco like myself, like to compare what is at different warehouses around the world.
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Really? You've been to Costco overseas?
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Of course.
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Which one?
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Oh, I'm sorry, I haven't been.
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Okay.
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But there are some subreddits.
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Oh, I love that.
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Where people will post. They said, I'm going to travel to a Costco in this country just to try this sushi that they have or things like that. So there's big fans, myself an. An executive member. So there's two types of membership. I pay for the one that's twice as much money because you get a 2% cash back if you're an executive member. And for me, the way I shop during the year, that money pays for the membership. So to get that cash back and membership fees alone, last quarter brought in $1.7 billion. So that is a cash cow for Costco. And just one more bit of information. They increased the fee by $5 just last year. And that was the first time in seven years. If you're talking about inflation, that's the first time in seven years that the fee went up.
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So I have to ask you, as an executive member, have you taken advantage of the special hour where the stores are open just for executive members like you?
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No. That's right. You've heard of that? That's right. They. They open one hour earlier just for executive members. And I haven't tried it yet. I have a pretty good system of going later in the evening when most people aren't shopping. But I'd like to try it. I'd like to see who, who else is there?
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So I do want to just compare this with that sort of gem inside Walmart, which is Sam's Club. Right, right. It's that other membership, this sort of warehouse retailer. Why have you picked Costco over Sam's Club?
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It's the return policy.
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What do you mean by that?
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So you can basically return anything at any time for any reason, no questions asked. And I've heard of people who abuse it. You know, maybe they have a mattress for two years and then they return it. I mean, that's people who abuse it. But I'll give you an example. Recently I'm getting married and I ordered a wedding band from the website and it arrived and it was not what I expected it to be. And so I went back to the Costco here in Manhattan. They took out a device to just make sure that it was the product that I had purchased. And it was. And an instant refund. I mean, to be able to shop with that level of security is excellent.
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Well, hang on a second. Didn't they do something? Do they bring out sparklers? Did they bring out champagne for you? So what did, I mean, you're getting married. Did they do something to acknowledge the enormity of the occasion?
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I bought it online, so there was no celebration.
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Sure. But when you went back in store to return it.
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Sure, they were happy for me.
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Okay, they did. I'm not hearing sparklers and champagne, for what it's worth. But. But let's talk a bit more about the financial profile of Costco and what it's trans. It's translating into and what it's not. Right. So these big box retailers, they operate at pretty skinny margins. We're talking single digit percent margin margins here when it comes to operating income and profitability. So they're really dependent on scale and the engine of that. And one of the reasons why the market has loved Costco as much, again, 150 appreciation and share price over the past five years. The market loves subscription businesses, they love membership businesses. Recurring revenue, sticky revenue. And that cash coming in up front even before you've gone into the store. Right. To, to spend on anything.
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Sure.
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14 billion, $14 billion in cash reported this quarter. So it's doing pretty well. It's got its scale, it's got its margin, it's got the cash flow coming off the back of it. But let's talk about what happened in response to this. Right. The share price kind of shrugged in reaction to this, down about 4% on that share price chart since the earnings report came out on Friday And Costco is down 1% year to date. And we thought it was worth just unpacking. Why? Because even though it had that miss on earnings and it was pretty slight, and again, growth when you're at this level of size is difficult to even see. Something close to 6% is pretty strong for retail, John, to be honest. So here's what I wanted to do. I wanted to unpack the mystery of this. And so I fully nerded out. So I'm asking you all to just stick with me and have some patience. I went and took a look at where Costco is trading and I looked at two particular metrics that really do stay with me on this. So this is looking at Costco's price to earnings ratio, which is means how much are you paying for a share price relative to the earnings per share that is likely to come out of it. Now, whether you look at the forward multiple, which is for the next 12 months, or the trading mult or trailing Multiple the last 12 months, Costco is trading somewhere between 45 to 55, 50 times. 45 to 55, 0 times Price to earnings ratio. Now the other metric that people like me nerd out on is the PEG ratio, which is the price to earnings to growth ratio, which is an indication of how much you're paying per sort of percent of growth expected for each of the next five years. So Costco trading at 45 to 55, 50 times PE is trading at nearly a five times price to earnings to growth ratio. So I thought, okay, look, just as an intellectual exercise, let's compare this with a growth juggernaut. Let's compare this with Nvidia. So John, give me a guess as to where you think Nvidia's PE is right now.
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Okay, well, the way you set it up, I Bet it's near 50.
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Is 50 exactly about 50 times pe for in Nvidia. And what do you think their price to earnings to growth ratio is?
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Okay, Costco's at 5. And the higher the number, the more expensive. I'm going to go less, I'll say three.
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No, Nvidia right now is at about 1.3 times. So that's sort of amazing for the poster child of AI, the fuel, the engine for the next, you know, the next engine of growth and technology is less expensive to buy on a growth basis right now than Costco. And we thought just to hammer the point home, this is an investment advice, it's a point of view. But to hammer the point home, Costco does have sort of a business to consumer subscription model. So we thought what's sort of an equivalent for that? Maybe software, which is a business to business subscription model. Sticky and recurring in this case, it's contractual. So a bit different. Palo Alto Networks, which is the cyber security business currently trading at, yes, you guessed it, about 50 times price to earnings ratio. And it's price to earnings to growth ratio less than two times. So again, less expensive than Costco when you factor in the relative rates of growth. And that in my opinion is why Costco's price has been nudging down, its stock has been nudging down. And you're going to see a lot of headlines out at the moment asking for both Costco and actually Walmart. Are they now at places where they're too expensive? Well, for those of you who enjoy using your Costco membership, let us know what that experience is like. Those of you who invest in the Costco stock, let us know what you think about the valuation. We don't have a perspective necessarily, but we do want to hear all different points of view and debate them a little bit. So do send us a note. Well, let's take a quick break and when we come back, what's an OPCO propco. We bust through the jargon. Well, here on Friday's show, we covered Six Flags and the fact that an activist investor, Land and Buildings Investment Management, has taken a stake in the theme park company. In a letter to shareholders, the activist argues that Six Flags could unlock $5.7 billion of real estate value if it pursues an OPCO PROPCO structure.
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That's right. And so I asked Ann for today's question from the audience to explain how an OPCO propco works.
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Well, if you've ever walked into a hotel, a restaurant, or even a big retail chain, the chances are that the business behind it is using this clever financial setup. Now, it sounds very complicated, but the reason we're busting through the jargon on this one is it's one of those instances where it's actually much more intuitive than the complicated name would suggest. A company that owns a lot of real estate for its operations splits into two. In an OpCo PropCo, it's split into an OpCo, which is short for operating company. That's the part of the business that literally runs things, hiring staff, serving customers, selling the product, getting it manufactured. The management team is experienced in the core operations of running hotels or retail stores or factories, whatever this industry is. Now, the other part of the split is a propco, which is short for property company. It only owns and manages the physical real estate that's the sole purpose for being. And it's led by a dedicated management team of real estate experts. Now, the operating company leases the property from the propco. OPCO literally pays rent to propco. So why do this? Well, first it lets the operating and property companies focus on what they do well and therefore raise money somewhat separately using different capital structures and valued using different metrics. For example, it can allow the property company to raise money from investors who just want stable rent like income. So think of it like a bond. They want predictable cash flow, lower risk. So propos often take out debt where the interest payments they have to make and the repayment of the debt they have to make flows in a way that sort of mimics the rent that that propco receives, usually as a Result raising more debt than the single company which doesn't have focus like this and so wouldn't be able to take as much debt out against its real estate portfolio. Meanwhile, the OpCo, again, it's focusing on what it does best can be valued as an asset like company which has different attractions, especially for equity investors. This is why opco propcos are seen as a way to unlock value. And it's often why you'll see this model in sectors that have been around for a long time where the biggest companies have bought up lots of properties over years and often over decades. And they have this moment suddenly where they say, how do we extract more money out of it? Hotels, for example. Let's take Marriott now. Marriott for example, now often runs the operations while real estate investors own the buildings. Marriott was founded in 1927. It's a very old company. But its OPCO structure didn't come about until the 1990s, by which time it had accumulated a big portfolio of owned real estate. Now there is a word of caution. There always is. Nothing's ever too good to be true. These structures do not always succeed in practice. The same investors often have ownership in both the OPCO and Propco, creating conflicts of interest more with private companies than with public ones. And sometimes the industry changes and the structure just isn't set up to evolve with it. One famous example is Toys R Us, which has roots back to 1948. It set up the Opco Propco structure in 2005. The retailer went bankrupt in 2018. It had failed to build e commerce capabilities to fight the growing threat of Amazon. Everyone stood around saying what are you guys doing about online? It wasn't doing enough, so its OPCO was declining. Made worse by the fact that the opco had lots of its own debt. Plus the rent it was paying to propco was high. And this is because the Propco had taken on lots of debt itself and needed that high rent to pay off its own propco interest burden. This really didn't end well. So Six Flags, founded in 1961, has to think really carefully about balancing a wish to unlock value from its real estate portfolio with not putting in place such high rents that the theme parks risk going under if there's a recession or consumers to stop wanting to go on roller coasters. This is going to be one about the balance of the demands of the activist investor and thinking very carefully about the capital structure. We're going to keep watching and I'm.
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Curious if there's ever going to be a Costco Avco, Propco.
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Let's keep watching that one.
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If you have a question for Ann, send an email or Voice memo to BrewMarketShoworning Bukom.
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Well, it's 4:00pm on the east coast and the markets have closed. Now, we don't have a ticker tape, but we'll throw it over to our human ticker, our producer John.
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That's right, The S&P 500 was up a quarter of a percent today. The Dow finished up a tenth of a percent and the NASDAQ was up nearly half a percent. Here's some market headlines. Shares of railroad giant CSX were up over 4% today after the company appointed a new CEO. This after activist investor Ancora holdings last month told the railroad operator that it could pursue a deal with a rival or replace its chief executive and a deal didn't materialize. And shares of cannabis companies were up today across the board after President Trump's social media post that highlighted the potential benefits of CBD and senior health care. Tilray brand stock was up 50% and Canopy Growth was up 18%. And finally, shares in Etsy were up nearly 15% today after OpenAI announced a new feature that lets you buy goods from US Etsy sellers through ChatGPT.
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Oh wow, there it comes. Direct to consumer retail now happening in the generative AI space. I guess it was just a matter of time actually John, so very curious to keep following that story. Now as a final thought, just wanted to shine a bit of a light on the deal that was announced. It's actually confirmed today and that is the take private of Electronic Arts. Now I have a background in private equity, so here's the reason that this caught my eye. The deal I have the announcement in front of me represents the largest all cash take private buyer private equity fund in history. This is a $55 billion deal and a conglomerate has come together to buy the business to take Electronic Arts private at roughly a 25 premium to where the share had shares had been trading before the news of this started to take hold and the rumors started to build momentum. Now the firms coming together to buy the business are the Saudi Arabian sovereign wealth entity pif, the private equity firm Silver Lake, and also Affinity Partners. Now the timing of this is very interesting. It is probably no accident that this is happening right as the market has some certainty now that interest rates seem to be on the glide path of coming down because real debt is going to be involved in this. Take private. It's also an interesting note on the rise in sovereign wealth funds in partnering with private equity funds to take private and to own ever bigger businesses, this one being a case in point. And those of you who listened to our interview last week with Lucid Motors interim CEO Mark Winterhoff will remember he and I talked about what was it like to have the Saudi Arabian sovereign wealth fund PIF in his cap structure. So we'll keep watching this one. We're going to come back and do a deep dive into what does this mean for the gaming sector? What does this mean for take private activity? What does this mean for the return of massive mega deals? Not just this kind, but also corporate mergers and acquisitions? Because we are seeing activity Pick back up. That's it folks, for today's blue Markets.
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Daily Brew Markets Daily is hosted by Anne Barry and produced by John Cotto, Tarek Abdelatif and Emily Milian. Our technical director is Luis Farias, audio assistants by Brittany De Taco and the president of Morning Brew, Inc. Is Devin Emery.
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Wake up tomorrow with the Morning Brew newsletter and tune in to Neil and Toby on Morning Brew Daily. We'll see See you back here tomorrow, same time, same place.