MorningWord 9/29/16: COST’$ Cut

by Dan September 29, 2016 10:01 am • FREE ACCESS

Costco (COST) will report fiscal Q4 results tonight after the close.  The options market is implying about a 3% move tomorrow in either direction. That’s rich to the 4 qtr average one day post earnings move of about 2.5%, and the 10 year average of 2%.

Back in late August, I had some thoughts (Big Box Stocks) on the stock when it was threatening a new 52 week & all time high:

The 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.

Oh what a difference a month makes. Shares of COST are down about 12% since mid August, with losses accelerating in Sept after the company reported disappointing Aug same store sales on Aug 31st.  If the company were to offer weaker than expected guidance for the current quarter, I suspect we will see the stock back towards technical support near $140 in the coming days:

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

This morning the Wall Street Journal’s Steven Russolillo said that Costco shares should continue to suffer under the weight of competition from and others, as AMZN’s:

annual revenue is expected to surpass Costco’s for the first time this year. By comparison, Amazon had less than half of Costco’s annual revenue six years ago.

Costco’s competitive edge lies in limited product selection, loyal customers and fee income. Its roughly 81 million card holders spent around $2.5 billion in membership fees in fiscal 2015, comprising the bulk of Costco’s $3.6 billion in operating income.

While Costco is still attracting new members, growth in fee revenue decelerated to 4.3% in fiscal 2015, the least since 2009, as exchange rates weighed and past fee-increases faded.

Make no mistake, that deceleration is a result of Amazon’s success with Prime shipping, per Business Insider:

According to a note published by Cowen & Co. on Monday, the percentage of US households that only pay for Prime membership has more than doubled over the past four years, from 7.1% in 2013 to 16.2% in 2016. In the same time span, housholds that only use either Costco (from 14.9% to 9.8%) and Sam’s Club (from 16.9% to 9.7%) dropped noticeably.

In the meantime, households that pay for both Prime and Costco memberships jumped from 4.8% to 11.3% in the past four years, while the same trend is seen among households subscribing to both Prime and Sam’s Club (from 4.8% to 8.5% in 2016).


This chart is a looming disaster for COST, as Prime will continue to grow, likely at the expense of COST:


And that 12% decline (since I last wrote about COST) has done little to help that premium earnings multiple.

There is massive disruption happening in the retail space. And Amazon is finally getting across the draw bridge over what was Costco and other food focused box stores’ protective moats.  It’s hard to imagine all these suburban box store complexes looking remotely the same in a few years. After all the Staples, and Sports Authorities and Bed Bath and Beyonds are gone, replaced by Amazon Prime, how long can the Costcos, Whole Foods and Sam’s Clubs survive? They’ll need to adjust quickly and concentrate on things same day and next day delivery (by drone?) can never replace.

I suspect Walmart’s (WMT) $3.3 billion deal to acquire in early August will not be a one off for beleaguered bricks and mortar retailers but could morph into investments in ride sharing or autonomous cars for delivery.


Lastly, a little bonus, I saw one of my favorite bands, Green Day last night in New Jersey, as usual they brought the house down. Enjoy, I did!

And here is the first track, Bang Bang, from their upcoming album Revolution Radio: