MorningWord 8/22/16: Big Box Stocks – COST, TGT, WMT

by Dan August 22, 2016 10:31 am • FREE ACCESS

Walmart (WMT) and Target (TGT) have been newsy of late. WMT’ made a $3.3 billion offer for online retailer a couple weeks ago, a company who’s store has been live for a little less than a year and has likely booked less than $200 million in sales.  While WMT’s acquisition was head-scratching to some, investors don’t seem too bothered yet with the stock just off 52 week highs.

On the flip-side, TGT continues to struggle to compete with the likes of (AMZN) online on most of their product line, while food and gas serve as more of a protective shield for WMT and Costco (COST). For now. Target shares fell 6.5% the day following their fQ2 results which were better than expected, with the company revealing weaker than expected second half guidance for earnings and comp store sales.

This past weekend I was at a friend’s beach house, and most of the consumer products, including food was Kirkland, COST’s private label brand.  As a city slicker who has spent the last 20 years living in New York City, (which is fairly devoid of big box retailers) I don’t have a ton of experience with such brands and primarily rely on Amazon Prime for non perishables and local grocery chains for food.  But seeing the Kirkland brand all weekend reminded me to do a little check-up on shares of COST as I headed into the office this morning.

This one year chart is pretty amazing. While it’s under-performed the broad market a tad (only up 4% ytd vs S&P500 up nearly 7%), what’s most striking is the stock’s tight consolidation since its better than expected June sales report (in early July). A long held assumption by analysts suggests that Costco’s business model is more Amazon-proof than WMT & TGT. The chart reflects that:

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

What’s equally striking though is the fact that COST trades nearly 32x (10 year high) expected fiscal 2016 eps growth of only 1% and 28x (what is expected to be a considerable acceleration in eps growth in fiscal 2017) of 13%, with sales growth expected to increase from 3% this fiscal year to 8% next (which would represent the largest yoy sales increase since 2012).

With a dividend yield of 1% and 28% of their sales from outside the U.S. it’s not so easy to explain why investors have piled into COST as a defensive stock.  Obviously the high margin of COST membership fees is one reason for the company’s premium multiple, and possibly the 5.8% growth in said fees in their last quarter. 88% renewal rates worldwide, extending total membership to 46.9 million, is the most likely reason for the stock’s 20% gains from its May lows.

The next identifiable catalyst for COST will be their August sales due on Aug 31st, which will crystallize the quarterly sales, then their full fiscal Q4 & 2016 results on Sept 28th.

The chart below of 30 day at the money implied volatility (the price of options – blue) vs 30 day at the money realized volatility (how much the stock has been moving – white) is interesting. Short dated options prices are at 52 week lows (as one would expect in this vol environment), and realized vol has collapsed, offering one of the widest gaps between the two measures likely in years:

From Bloomberg
From Bloomberg

With two events by the end of September, and the Fed’s rate meeting a week before earnings, owning options in names with like COST with upcoming events could be the way to play for upcoming volatility. We’ll take a closer look at trades in the near future.