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Costco: Bulls Shall Remain Bulls


  • 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.

Image credit

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

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

DM Martins Research profile picture

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.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (10)

Stock always traded a little rich. When I bought a number of years ago in the 40's I knew paying for growth would pay off, which it has.

Well worth paying up !
DM Martins Research profile picture
Just a bit surprised by the -2% reaction today. With the S&P 500 up slightly, I would have expected COST to trade on par. Might be in sympathy to Kroger and an overall weak retail sector.

Still, I'm not a big fan of the stock at current levels.
The report had good news but the investors want even more. Maybe they're a little spoiled by history.
cyrano13 profile picture
Projected conversion 30% of Sam's Club members should help bottom line in next quarter
don't sell now.
The Benjamin Fund profile picture
Zero chance they get 30% of Sam’s Club members to convert. Most of the closures are in markets with other Sam’s stores, and most already had Costco stores as well. Those customers are already inclined to be Sam’s members, and its tough to see a scenario where significant numbers defect to Costco.

FWIW, management addressed it on the conference call and seemed to suggest they were looking at 10%-20% conversion of the members attributable to those specific stores (which is around 10% of the total Sam’s Club Store base, but the closures have fewer than average members than the overall chain). So we’re probably looking at 1.0-1.5% conversion of all Sam’s Club members which frankly is going to be rounding error in terms of the overall growth for Costco as they’re doing 4x-5x that level every quarter anyway.
lew69sd profile picture
I bought 500 COST this morning at 183.50. Buy the dip. Earnings were very very good. The stores in my town are jam-packed every time I go.
Go buy a couple slices of supreme pizza to go with that 500!
it's become a little frothy. But you pay for quality....they are among the top tier of the retail sector
Exactly! The top 3 retailers are now: Amazon, Walmart, & Costco.
MauiJim95 profile picture
The big drop last summer really hurt it. It’s recovered well. That indicates a well run company. Thanks to them adding self-check lines, shoppers that just need a few items can get in and out very quickly. This could really improve foot traffic. +They are now paying (cash in many cases) the annual cash back on their Visa card. Nothing like leaving a store with 4-5 Hundred dollar bills in your hand. Seriously!
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