oliver7's  Instablog

Examining both companies in the context of our macroeconomic environment, we seek to BUY COST and SELL WFMI. Although they are not direct competitors, the idea is that consumers will start shifting from Whole Foods Market, the premium grocer, to Costco, the big box giant.

The Picture:

First and foremost, consumers are already trying to drive less as the price of oil sends gasoline prices back up to record highs. This means consumers will be looking to buy in bulk for an entire month instead of 4 weekly trips to WFMI.

In addition to increasing oil prices, consumers are feeling the commodity pinch at the grocery store. WFMI (or "Whole Paycheck Market") is already notorious for being over-priced. But will they be able to pass higher prices onto their customers? Don't be surprised if their margins start to shrink from 3% to the industry average of 2%.

Due to the current lack of inflation, consumer goods such as electronics and clothing will see increased demand as they remain relatively cheap compared to commodities. COST, we believe, will have a tremendous advantage over its grocery store counterparts due to its large electronics and clothing outfits.

The Trade:

COST and WFMI have a 0.77 and 1.15 beta, respectively. A beta neutral position would be 2-to-3 long-COST short-WFMI ratio. COST currently yields a 1.2% dividend and trades at a cheaper P/E multiple of 25 vs. 37 for WFMI.

WFMI is set to report earnings Wednesday after the close. COST reports May 25 before the open.