Event: COST reports its fiscal Q1 earnings on Wednesday, Dec 11th before the open. The options market is implying about a 2.25% one day move, which is above both the 4 qtr avg of about 1.25% and the 8 qtr avg of about 1.5%.
Sentiment: Wall Street analysts are mixed on the stock, with 14 Buys, 15 Holds and 1 Sell, with an average 12 month price target of around $123. The stock has been very consistent, gaining 15-25% in 2010, 2011, 2012, and so far in 2013.
Options Open Interest: Open interest actually has more puts than calls outstanding (54k vs. 49k), but it’s worth noting that most of the put open interest is no longer relevant since the stock has rallied far away from those strikes in the past year. The volume over the past month has been skewed to calls, though, trading on average 4k calls per day vs. 2800 puts per day. The Dec 125 calls and the Jan14 120 calls both have over 4k of open interest.
Price Action / Technicals: COST’s chart continues to be a very impressive demonstration of a persistent uptrend. Consistent Costco indeed – all of the major moving averages have been upward sloping for almost the entire period since 2010, and the stock has only traded below its 200 day moving average for a few days since 2010. Quite an amazing run for a $50 billion market cap company:[caption id="attachment_33488" align="alignnone" width="600"] COST daily, 50 day ma in pink, 100 day ma in green, 200 day ma in yellow, Courtesy of Bloomberg[/caption]
On a shorter-term basis, the important level to watch on the upside will be the all-time high achieved in November, at $126.12 On the downside, the $120 level was resistance on several occasions in the summer and fall before the stock broke out in November. That will be the first level of support to watch on the downside.
Fundamentals: On Thursday of last week (Dec. 5th), COST had its highest volume day since its Oct. 9th earnings report. That Dec. 5th decline was a result of a weaker than expected total comp sales report, in which sales increased 2%, vs. an expected increase of 3.5%. The 2% year over year gain was the smallest for Costco in any month since September 2009, with lower gas prices the main culprit according to management. The stock fell 1.6% on Thursday in response.
Despite those sluggish November sales figures, analysts are forecasting a strong earnings report on Wednesday morning, projecting a 7% rise in sales and a 8% rise in earnings. This quarter’s report will be closely watched after its prior earnings report (only 1% earnings growth) was its most sluggish in more than 3 years.
Sales estimates over the next 3 years are in the 5-10% range, while earnings estimates are in the 10-15% range. But valuation could be the one concern, especially relative to other large cap retailers like WMT or TGT. Those 2 stocks are valued in the 15x P/E multiple area, with expected earnings growth in the 8-10% range over the next few years, only a few percent below COST, which is valued around a 25x P/E multiple.
Volatility: Realized volatility in COST throughout 2013 has been very low. In fact, 30 day realized volatility has not moved above 20 for the all of 2013:[caption id="attachment_33468" align="alignnone" width="600"] COST 30 day realized volatility (blue) vs. 30 day implied volatility (red), Courtesy of LiveVolPro[/caption]
Meanwhile, implied volatility is also below 20 ahead of the earnings event this week. While that’s lower than normal ahead of earnings, the holiday season is fast approaching, so there is little expectation of volatility for traders after the event is out of the way. In short, options prices are cheap, but for good reason.
Our View: With some of the short-term bad news out of the way after the weak comp sales report on Thursday, expectations for the earnings report have likely been ratcheted lower. Yet, the overall analyst projections are still for 7% earnings growth, which implies much better results from COST earlier in the fall.
While the valuation is more expensive than peers, COST has also been a very consistent business in the past 5 years. Market participants gave the company the benefit of the doubt after a weak October earnings report, but the stock is up almost 20% since the stock’s low on the day of earnings. In the short-term, given the stock’s appreciation and overall valuation, a breach of the November high around $126 seems unlikely if COST does not increase 2014 guidance.