Over the last year or so, one of the most disruptive companies in the marketplace has been Amazon (AMZN). Their acquisition of Whole Foods in August of 2017 put grocery and food stocks on edge in a big way. Next, rumors began floating across the market that they were thinking about branching into the pharmacy business. Along the way, businesses that AMZN regularly competes with, like Walmart (WMT) and Target Stores (TGT) suffered, while other stocks like Kroger (KR), CVS Health Corp (CVS) and Walgreen’s Boots Alliance (WBA) were caught in the crossfire. Through it all, one stock in the retail sector that many investors might have thought would be just as susceptible to increased competition from AMZN is Costco Whole Corporation (COST).
The interest thing is that through 2017, COST’s stock performance trailed the overall market and actually finished the year slightly negative; but over the past twelve months the stock has been among the market leaders, surging more than 40% over that period and nearly 25% year-to-date. Why? The company operates with famously low margins on its retail sales, since it sells at a mere fraction above its costs; but it has managed to see consistent earnings growth via its subscription-based membership, which boasts high annual renewal rates and which provides most of the company’s true operating margin. And while competition form AMZN is no laughing matter, it’s worth noting that investors seem to think the company knows how to weather that storm, just as it has in the past. It is noteworthy that during the Great Recession beginning in 2008 with only a one-time 1% revenue decline in 2009.
As we move into the colder months of the year, and we start to gear up for the holidays, a lot of attention is going to turn to retail sales and how healthy they are this year versus last year. This might seem like a good time to think about working with one of arguably the best-run companies in the market right now, and you might even be right if you want to think about placing a short-term, momentum-based trade; but the big question any long-term investor should ask before they take an investment in COST is what kind of stock it really is. The truth is that there is no way right now you can call this stock a value play; every useful metric for a stock’s intrinsic value says this stock is significantly overpriced right now. That means that no matter what the stock’s fundamentals are, a long-term investment in our current market climate in COST actually offers far more risk than it does upside. Let’s dive in and take a look.
Fundamental and Value Profile
Costco Wholesale Corporation is engaged in the operation of membership warehouses in the United States and Puerto Rico, Canada, the United Kingdom, Mexico, Japan, Australia, Spain, and through its subsidiaries in Taiwan and Korea. As of August 28, 2016, the Company operated 715 warehouses across the world. The Company’s average warehouse space is approximately 144,000 square feet. The Company’s warehouses on average operate on a seven-day, 70-hour week. The Company offers merchandise in various categories, which include foods (including dry foods, packaged foods and groceries); sundries (including snack foods, candy, alcoholic and nonalcoholic beverages, and cleaning supplies); hardlines (including appliances, electronics, health and beauty aids, hardware, and garden and patio); fresh foods (including meat, produce, deli and bakery); softlines (including apparel and small appliances), and other (including gas stations and pharmacy). COST’s current market cap is $102.7 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings grew almost 13.5% while revenue growth was modest, posting an increase of almost 4.99%. Over the last quarter, earnings increased almost 39% while revenues increased a little more than 37%. The company operates with a very narrow profit margin profile, with Net Income running consistently between 2.2% and 2.3% of Revenues over the past year as well as the past quarter.
- Free Cash Flow: COST’s free cash flow is adequate, at a little more than $2.8 billion. This is a number that has declined since the third quarter of 2017 from a little above $4.4 billion.
- Debt to Equity: COST has a debt/equity ratio of .50. Their balance sheet shows almost $6.5 billion in cash and liquid assets versus about $7.2 billion in long-term debt, which is a pretty good indication that the company works with a conservative debt management philosophy. Their healthy cash position is a good indication that they easily service the debt they carry.
- Dividend: COST pays an annual dividend of $2.28 per share, which translates to a yield of a little less than 1% at the stock’s current price.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for COST is $29.90 and translates to a Price/Book ratio of 7.84 at the stock’s current price. Their historical average Price/Book ratio is only 5.92, which means the stock is trading at a premium of nearly 24.5% right now. The stock’s overvalued state is also supported by the fact the stock is trading more than 32% above its historical Price/Cash Flow average.
Technical Profile
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: The stock’s upward trend since April of this year easy to see; it’s also interesting that while the stock market was enduring its first legitimate correction beginning in January of this year, COST managed to mostly hold serve before surging from around $183 per share to its high a little above $245 per share in early September. Even as the market has moved into a second corrective pattern since the end of September, COST is once again proving to be pretty resilient, which is one of the reasons I’ve seen a number of analysts right now talking about it as a potential buy even in current market conditions. The stock appears to be breaking above resistance right now at around $233, and could use that break to push back to test its 52-week highs around $245. The strongest support point is around $224 based on the stock’s two pivot low points during October.
- Near-term Keys: If you’re looking for a way to take advantage of the bullish side of the market with COST, the stock’s current surge could be a decent signal right now to work with a short-term bullish trade by buying the stock or buying call options. A bearish trade isn’t a good probability trade right now, but if the stock’s bullish momentum fades, a drop below $220 would be a good indication the upward trend that it is still holding since April is about to reverse. That could be a good opportunity to short the stock or work with put options, with a target price in the $207 to $210 price area. If you’re looking for a value-based trade, COST is definitely not the one to work with right now. The stock would need to drop somewhere between $160 and $177 per share before most value investors would start to take it seriously at all.