Trade Costco If You Must, But It’s Not For Me

Costco Wholesale (COST) released the company’s fiscal fourth quarter financial results Thursday afternoon. For the 16-week period ended August 28, Costco posted GAAP EPS of $4.20 on revenue of $72.09B. The print met baseline expectations by three cents and represents net income of $1.868B, up 11.8% year-over-year comp. The top-line result also beat Wall Street, showing a year-over-year increase of 15%.

Membership fees increased 7.5% to $1.327B, slightly beating expectations. Currency exchange rate conditions negatively impacted this number by $29.8M. The firm ended the period with 118.9M cardholders and 29.1M paid executive members, up 2% and 4.3%, respectively. Renewal rates were a record 92.6% in the US/Canada region and 90.4% everywhere else.

Sales Comp

Comparable sales for the fourth quarter were as follows…

US: +15.8% y/y, adjusted +9.6% y/y.

Canada: +13.4% y/y, adjusted 13.7% y/y.

International: +2.9% y/y, adjusted +11.3% y/y.

E-commerce: +7.1% y/y, adjusted +8.4% y/y.

Total Company: +7.1% y/y, adjusted +8.4% y/y.

– Adjustments were made for the impact of currency exchange rates and fuel price volatility.

Edge Compression

This was not in the press release. You had to listen to, or read a transcript of the post-earnings conference call to know what CFO Richard Galanti had to say about the margin.

Gross margin printed at 10.18%, down 74 basis points from last year’s comp of 10.92%. Excluding gasoline, the decline would have been 22 basis points. Core merchandise margin fell 67 basis points or 23 basis points ex-gasoline. Overall, gasoline has hurt margins disproportionately as gasoline sales have increased and gasoline is a low margin business for Costco.

Balance sheet

Costco ended the period with a net cash position of $11.049B, which was down about $1B over the past year and inventories of $17.907B, which were up more than $3B over that same time frame. This left current assets at $32.696B, up about $3B. Current liabilities are $31.998B, giving the firm a current ratio of 1.02. That ratio matches, but barely. A quick ratio of 0.46 may or may not be a problem depending on how well the firm manages inventory valuation under an uncertain environment.

Total assets are $64.166B. The firm does not claim any value for “goodwill” or any other intangible asset. Of course, the name alone has great value. Total liabilities minus equity come to $43.519B including long-term debt of $6.484B. Other than the current situation, this balance sheet is in good shape. It is clearly more dangerous to carry an increased level of current assets in inventory than in cash. That being said, I am relieved to note that Costco is carrying almost twice as much cash on the books as debt.

Wall Street

A number of sell-side analysts have weighed in on COST since the earnings release on Thursday. However, I have only noticed three that I consider highly rated by TipRanks. All three are rated five out of five stars.

Truist Financial’s Scot Ciccarelli maintained his “buy” rating, and lowered his price target from $571 to $559. Oppenheimer’s Rupesh Parikh maintained an “outperform” rating and lowered his price target from $600 to $550. DA Davidson’s Michael Baker hung on to his “neutral” rating, increasing his target from $440 to $445.

Conclusion

Costco is performing very well. It always does. That’s what Costco is known for. The reality is that even at this morning’s discount, the stock trades at 37 times forward-looking earnings, which is very expensive in this market. The dividend yield of 0.74% does nothing to make the price tag look more attractive.

As your upside catalyst, which is something that Market Recon readers know I’m looking for it these days, Costco has two, maybe. However, it doesn’t look like it’s about to happen. The firm has been known to pay large special dividends to shareholders in the past. No such comment has been made recently.

The other would be an increase in the annual membership fee. Costco could pull this off in this environment, since what it sells is needed by households and businesses, and they sell it in bulk at a perceived value. The firm can pull this one out of its hat if necessary, but that’s down the road. CEO Craig Jelinek floated that idea for a while last week.

Readers can see that the cup and handle pattern I drew up for you earlier this summer failed around the $564 level. The decline that appears to be accelerating followed. Relative Strength is very weak. The daily MACD is in bad shape. The stock is now trading below the volume shelf created above the $510 level. That will provide for stiff algorithmic resistance at that level when the stock recovers.

Meanwhile, the 50-day SMA is trending lower, and the 200-day is about $45 higher than the last sell-off. “That looks technically attractive” said no portfolio manager ever. The stock is in danger of cracking the lower limit of my Pitchfork model. I am of the opinion that COST cannot be bought until we see if that level prevails.

Not that it has to happen, but if this Pitchfork were to fail, the lows of last May would not be unrealistic. The daredevils out there could sell October 21 $420 puts for $3+. The quick payday of that $3 premium could become very expensive in a month. I’m not that brave or that reckless.

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