Trade Costco If You Must, But It's Not for Me

Costco Wholesale (COST) released the firm's fiscal fourth quarter financial results on Thursday evening. For the 16 week period ended August 28th, Costco posted GAAP EPS of $4.20 on revenue of $72.09B. The bottom line print beat expectations by three cents and represents net income of $1.868B, which was up 11.8% from the year ago comp. The top line result also beat Wall Street, and showed a 15% year over year increase.

Membership fees increased 7.5% to $1.327B, slightly beating expectations. Currency exchange rate conditions imposed a negative impact on this number of $29.8M. The firm ended the period with 118.9M cardholders and 29.1M paid executive members, up 2% and 4.3%, respectively. Renewal rates hit an all time high of 92.6% in the US/Canada region and 90.4% everywhere else.

Comp Sales

Comparable sales for the fourth quarter were as follows...

US: +15.8% y/y, adjusted +9.6% y/y.

Canada: +13.4% y/y, adjusted 13.7% y/y.

International: +2.9% y/y, adjusted +11.3% y/y.

E-commerce: +7.1% y/y, adjusted +8.4% y/y.

Total Company: +7.1% y/y, adjusted +8.4% y/y.

- Adjustments were made for the impact of currency exchange rates and volatility in fuel prices.

Margin Compression

This was not in the press release. You had to either listen to, or read the transcript of the post-earnings conference call in order to know what CFO Richard Galanti had to say about margin.

Gross margin printed at 10.18%, down 74 basis from last year's comp of 10.92%. Excluding gasoline, the decline would have been 22 basis points. Core merchandise margin dropped 67 basis points or 23 basis points ex-gasoline. Overall, margin has been hurt disproportionately by gasoline as gasoline sales soared and gasoline is a low margin business for Costco.

Balance Sheet

Costco ended the period with a net cash position of $11.049B, which was down about $1B over the past year and inventories of $17.907B, which was up more than $3B over that same time frame. This left current assets at $32.696B, which is up about $3B. Current liabilities amount to $31.998B, leaving the firm with a current ratio of 1.02. That ratio passes muster, but just barely. A quick ratio of 0.46 may or may not be problematic depending on how well the firm manages inventory valuation subject to an uncertain environment.

Total assets add up to $64.166B. The firm claims no value for "goodwill" or any other intangible asset. Obviously, the name alone carries a great deal of value. Total liabilities less equity comes to $43.519B including long-term debt of $6.484B. Beyond the current situation, this balance sheet is in good shape. Obviously carrying an elevated level of current assets in inventory is riskier than in cash. That said, I find it comforting to note that Costco is carrying almost twice as much cash on the books as debt.

Wall Street

A number of sell-side analysts have opined on COST since these earnings were released on Thursday. I have, however, only noticed three that I consider to be highly rated by TipRanks. All three are rated at five stars out of five.

Scot Ciccarelli of Truist Financial maintained his "buy" rating, while reducing his target price from $571 to $559. Rupesh Parikh of Oppenheimer maintained an "outperform" rating, while cutting his target price from $600 to $550. Michael Baker of DA Davidson hung onto his "neutral" rating, while increasing his target from $440 to $445.

Conclusion

Costco is executing very well. It always does. That's what Costco is known for. The fact is that even with this morning's discount, the stock trades at 37 times forward looking earnings which is very expensive in this market. The dividend yield of 0.74% does nothing to make the price tag look more attractive.

As for upside catalysts, which is something that Market Recon readers know that I am looking for these days, Costco has two, potentially. Neither however, appears to be imminent. The firm has been known to pay out to shareholders large special dividends in the past. There has been no mention recently of such an occurrence.

The other would be an increase made to the annual membership fee. Costco could quite possibly pull this off in this environment, given that what it sells are what households and businesses need, and they sell it in bulk at perceived value. The firm may pull this one out of its hat if need be, but that's down the road. CEO Craig Jelinek just put that idea to rest for a while last week.

Readers can see that the cup and handle pattern that I drew up for you earlier this summer failed up around the $564 level. A downtrend that only appears to be accelerating has followed. Relative Strength is very weak. The daily MACD is in poor shape. The stock has now traded below the volume shelf that had been created above the $510 level. That will provide for stiff algorithmic resistance at that level when the stock does recover.

In the meantime, the 50 day SMA has started to trend lower, while the 200 day is flatlining about $45 above the last sale. "That looks technically attractive" said no portfolio manager ever. The stock is in danger of cracking the lower bound of my Pitchfork model. I am of the opinion that COST can not be bought until we see if that level holds.

Not that it has to happen, but should this Pitchfork fail, the lows of this past May would not be unrealistic. The daredevils out there might sell October 21st $420 puts for $3+. The quick payday of that $3 premium could get really costly in a month's time. I am either not that brave or not that reckless.

(Costco is a holding in the Action Alerts PLUS member club. Want to be alerted before AAP buys or sells COST? Learn more now.)

At the time of publication, Stephen Guilfoyle had no position in the securities mentioned.