Costco: Bulls Shall Remain Bulls
Summary
- Costco's earnings release, even if pointing at solid results, was uneventful in my opinion.
- February came in strong to drive the top line beat, while I think the EPS miss was mostly indicative of the Street's overly aggressive expectations.
- COST bulls have no reason to be disappointed with the company and its performance, but I don't see much alpha to be realized here.
If I had to pick a word to describe Costco's (NASDAQ:COST) fiscal 2Q18 earnings results, reported after the closing bell on Wednesday, I would choose "uneventful."
This is not to say that the numbers were not solid. But in my view, I believe the big-box retailer performed pretty much in line with what attentive investors should have been expecting. February, the only month of sales not already announced prior to the earnings report, came in strong to drive the $280 million top line beat. Meanwhile, the four-cent non-GAAP EPS miss suggests to me that the Street might have kept the earnings bar raised too high this time.
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The table below summarizes the results of the quarter.
Gross margins remained resilient at 12.9%, even if I deduct membership revenues from the YOY comparison. The trend is pretty consistent with what we have seen in previous quarters, which makes sense given the company's policy of everyday low prices. The benefit of the membership model is that, even though gross margins are very slim compared to the industry's average, they are also unlikely to fluctuate much over time.
Opex as a percentage of revenues declined by about 30 bps YOY, the best op leveraging effect seen since at least mid-year 2017. Despite the debt issued last year to cover the special dividend, net interest remained largely a non-issue, while a slightly higher effective tax rate (adjusted for a one-time benefit) caused what I estimate to have been a penny drag to EPS.
Source: DM Martins Research, using data from company reports
My takeaways
At first glance, there was nothing about Costco's earnings report to give me reasons to be more or less bullish about the company and the stock. For this reason, I believe shares are likely to trade more or less in line with the broad markets today.
Source: YCharts
On my end, I continue to be more of a skeptic than a cheerleader. While I recognize that Costco is a great company with a superior business model that has proven to be less susceptible to pricing pressures and the Amazon (AMZN) threat, I do not see enough catalysts to push this stock any higher than it already is, at least relative to the broad market (see chart above). Comps above the mid-single digits (see below) are already at what I perceive to be a peak, and do not believe they will move much higher as Costco starts lapping a pretty decent second half of fiscal 2017.
Source: DM Martins Research, using data from company reports
For these reasons, I prefer to leave COST alone, as I believe there is little alpha to be found with this name.
Note from the author: I do not own COST in my portfolio because I believe I can generate long-term growth with limited downside risk in a much more efficient way. This is why I built my Storm-Resistant Growth Portfolio. To learn more about it, click here and take advantage of the 14-day free trial.
This article was written by
Daniel Martins is a Napa, California-based analyst and founder of independent research firm DM Martins Research. The firm's work is centered around building more efficient, easily replicable portfolios that are properly risk-balanced for growth with less downside risk.
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Daniel is the founder and portfolio manager at DM Martins Capital Management LLC. He is a former equity research professional at FBR Capital Markets and Telsey Advisory in New York City and finance analyst at macro hedge fund Bridgewater Associates, where he developed most of his investment management skills earlier in his career. Daniel is also an equity research instructor for Wall Street Prep.
He holds an MBA in Financial Instruments and Markets from New York University's Stern School of Business.
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On Seeking Alpha, DM Martins Research partners with EPB Macro Research, and has collaborated with Risk Research, Inc.
DM Martins Research also manages a small team of writers and editors who publish content on several TheStreet.com channels, including Apple Maven (thestreet.com/apple) and Wall Street Memes (thestreet.com/memestocks).
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (10)
don't sell now.
