Name That Trade – $COST Conscious

by CC September 30, 2015 11:45 am • Commentary

Costco reported better than expected fiscal Q4 earnings results last night that featured strong membership fees. The results also marked the company’s second consecutive quarterly comp store sales decline of 1%. But excluding the adverse affects of the strong dollar and low oil prices, comps would have been up 6% in the period. I guess one way to look at this is what will comps be if the dollar stays bid and oil stays low?

Valuation: We have struggled with COST’s valuation in the past, and given the performance of other big box retailers, the stock trading at 25.5x expected fiscal 2016 earnings growth of 8%, and 27x trailing places it very near a 10 year high, per Bloomberg:


Technicals:  A quick look at the one chart of COST shows the stock’s sharp decline from the mid $140s in August to below $130 on August 24th, with a $132 open, and and $133 close on the day of the flash crash:

[caption id="attachment_57267" align="aligncenter" width="600"]COST 1yr chart from Bloomberg COST 1yr chart from Bloomberg[/caption]

With a look at the 7 year chart, from the Q1 2009 lows, the uptrend that at its highs earlier this year resulted in 300% gains from its trough, has held like a boss, and interestingly sits at $130 (which seems like a fairly reasonable target on its next pullback:

[caption id="attachment_57268" align="aligncenter" width="600"]COST 7 year chart from Bloomberg COST 7 year chart from Bloomberg[/caption]

Volatility Snapshot:  Short dated options prices have traded between a range of 15% implied volatility and 30% over the last month, now settling in near 20%, which is likely to creep lower if the broad market were to stabilize:

[caption id="attachment_57269" align="aligncenter" width="600"]COST 1yr chart of 30 day at the money IV from Bloomberg COST 1yr chart of 30 day at the money IV from Bloomberg[/caption]

But if the broad market were to continue bouncing around the way it has in the last couple months, then economically sensitive stocks like COST could come back into focus. Those looking to express directional views in such a name would find options prices on the cheap side.

Our View: With the earnings news out of the way, which was clearly mixed, the stock’s fairly tepid reaction, and headwinds that are not likely to be abate, we like the set up for playing for the move back to trend. COST is an expensive stock that probably reflects a lot of good news in the near term. However, we need to see how today’s bounce in the broader market plays out. If the bounce continues, a short delta trade would make more sense at $147 in COST (the highs from this Summer that also failed a few days ago). We want to be patient and wait for either a reversal in the broader market or that ideal entry closer to $147. At that level we’d likely look to do the Nov 145/135 put spread. Currently at 3.00 this would be under 2.50 at those levels. If the market looks like it will roll over we’d likely look to buy a put outright and leg into a put spread with the stock lower.