Don't Rush To Buy Costco On Earnings Strength

Headwinds May Keep Costco Shares From Moving Higher

Costco NASDAQ: COST is a great company, don't get us wrong. It is one of the biggest beneficiaries of the pandemic, the company is still expected to grow long into the future, and it pays a very safe dividend. The problem that we have with the stock right now is that it's very highly valued, it pays a very low yield, and the revenue comps in the next quarter are going to be very very tough. The fourth fiscal quarter of the year is traditionally a strong one for Costco but last year the company set a record of $53 billion Which was up 12% from the previous quarterly record. Because the current consensus estimate for the 4th quarter is only $43 billion there is a very great chance this company will post negative year-over-year earnings growth in the next reporting cycle. The takeaway is that as good as the Q3 was Costco may be trading at a peak right now.

Costco Revenue Growth Accelerates In Q3

Costco had a great third quarter. The company reported 44.38 billion in net revenue which is up 21.7% from last year and beat the consensus by 120 basis points. Notably, the company beat the consensus, the problem we see is that the beat is not very large and may not be rewarded by the market. On a comp basis, Canada leads with a sales increase of 32.3% followed by 18.2% in the US. Those gains are compounded by rising fuel prices, however, so on an adjusted basis, Canadian Revenue growth came in at 16.7% while that in the US came in at 15.2%. Sales also continue to be underpinned by e-commerce. Sales through the digital channels Rose 38.2% during the quarter.

Looking forward, the revenue gains should be sticky if not lead to further growth because of rising levels of membership. The company's membership fees increased 11% over the last year and topped the consensus by 300 basis points. Membership fees are about 2% of the net revenue.

Moving down to the earnings portions of the report the company's operating margin widened by 50 basis points over the past year. That drove the Gap EPS to $2.75 and beat the consensus by $0.41 while at the adjusted level EPS of $2.84 beat by  $0.56.  The bad news is that even with the .$056 beat the company is still on track to fall short of the full-year earnings consensus estimate.

Costco: A Highly-Valued Yield

Costco is attractive as a dividend grower. The company has solid earnings, a healthy balance sheet, and a history of dividend increases. The problem is the stock yields well below 1% and trades at nearly 40X its earnings. Investors who wish to have exposure to the membership retail industry would be better served by Walmart/Sam’s Club. Walmart trades at roughly two-thirds the cost and pays twice the yield, and it's also a growing concern. We'd be more interested in Costco at a lower price and a higher yield.

The Technical Outlook: Costco Is Pulling Back From The All-Time High

Shares of Costco were volatile and after-hours trading following the release of Q3 earnings.  Shares of the stock were trading lower going into the opening bell and look like they may pull back at least on an intraday basis. Our concern is that resistance is apparent at the current all-time high and when looking at the weekly charts it appears as if the stock is tracing out a double top. We could be wrong, the stock may be ready to move higher, but we don't think so. In our view, this stock is ripe for another correction that could shave 5 to 10% of value off of share prices.

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