New Trade – Opportunity $COST

by Dan December 11, 2013 2:26 pm • Commentary

I laid out my thoughts on COST this morning (below), and Enis previewed their earnings on Monday. Today, following earnings, the stock bounced off its lows of the day of around 117 and recently made a run back at its 50 day moving average that sits at about 120. We think that COST’s two consecutive earnings disappointments and last month’s same store sales print at the lowest level since September 2009 could cause the stock to find serious short term resistance at the 120 level for the next month or so and we will look for a pullback that could see it in the mid teens after all is said and done.

Heres’ the trade:

TRADE: Bought the COST ($119.15) Jan 120/115/110 Put Butterfly for 1.15

– Bought 1 Jan 120 put for 2.77

– Sold 2 Jan 115 puts at .99 (1.98 total)

– Bought 1 Jan 110 put for .36

Breakevens on Jan expiration:

Profits: btwn 118.85 and 111.15 make up to 3.85, with max gain of 3.85 at 115.

Losses: losses of up to 1.15 btwn 118.85 & 120 and btwn 110 & 111.15 with max loss of 1.15 below 110 or above 120.

Trade Rationale:

After earnings COST now finds itself between resistance at 120 (50 day moving average) and support at around 113 (200 day moving average.) This strategy looks to play for a move lower with today’s highs serving as resistance





MorningWord 12/11/13:  Costco is having a bad week…….this morning the big box discount retailer reported fiscal Q1 results that missed on eps and on sales, just a week after reporting worse than expected same store sales for the month of November.  The stock is trading down about 2% in the pre-market, and is now down about 6.5% from the all time highs the stock made in the days before Thanksgiving.

In our COST quarterly preview (here) from Monday, Enis summed up what will likely be the hot button issue for the discount space as we head into the new year – relative valuation among its peer group:

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.

I think it is also important to note that when the company reported fiscal Q4 earnings back in early Oct, COST missed analyst eps and sales estimates, intially sending the shares down a couple percent only to reverse and have them close up a couple percent. From the lows following the Q4 report the stock went on to make new all time highs, rising 14%, besting the SPX’s 9% gains in the same period.

Which brings me to a statement that we have made on this site and on TV on more than a few occasions of late – sometimes when things can’t get any better for a company and its stock, they don’t. I find myself routinely asking the rhetorical question, “Where the heck do you think this thing is going at all time highs on a runaway breakout at this valuation???”

Take a look at the chart of COST since 1995.  At any point above $80 over the last two years you could have made an argument that the stock’s ascent was getting quite steep, but come on people, the news has not been good of late, 2 company specific disappointments (mentioned above) and very disappointing results from its peers TGT and WMT,

COST since 1995 from Bloomberg
COST since 1995 from Bloomberg

On a near term basis, the one year chart could be fairly instructive to what we could expect to see into the new year.  This morning’s pre-market activity suggests a break of the 50 day moving average (purple line) and the breakout level that was staunch resistance for most of the summer into the fall.  The next real support level is just above the 200 day moving average at $113.25 (yellow line), while $110 (red line), the low on two occasions in the last few months could be an attractive entry for a long side trade, if it gets there anytime soon.

COST 1yr chart from Bloomberg
COST 1yr chart from Bloomberg

But technicals aside, COST has now missed earnings for 2 straight quarters, registered only 1% year-over-year earnings growth for both.  The first miss could be forgiven as a one-off event, but now that it’s two in a row, market participants could start to ask more questions about the underlying strength of Costco’s business.  It could be saturation from prior growth, increased competition, or simply a poor macro environment.  Whatever the reason, COST shareholders have hardly ratcheted down expectations despite 6 months of weak operating results.  That might change after today.