Costco Looks to be Setting Up for another Move Higher Ahead of Earnings

Earnings

Wholesale retailing giant Costco (COST) is getting ready to release its fiscal second quarter results for 2021. The report is due out on March 4, after the closing bell. With the report, the company will be looking to maintain the momentum in its earnings growth that has helped push the stock higher in recent years.

Costco has seen its EPS grow at a rate of 19% per year over the last three years and it saw the EPS jump by 32% in Q1. Revenue jumped by 17% in Q1 and that was a big increase compared to what the company has averaged in recent years. Revenue has grown by an average of 8% per year over the last three years.

For 2021 as a whole, analysts are looking for earnings growth of 15.5% and revenue growth of 10.3%. For the second quarter, the current consensus estimate is for earnings of $2.44 per share and that would be a 16.2% increase over the $2.10 EPS the company reported in Q2 2020. Revenue is expected to come in at $43.75 billion and that is 12% higher than last year’s quarterly revenue.

Costco’s profitability measurements are somewhat mixed. The company’s return on equity is well above average at 28.5% while its profit margin is below average at 3.6%. The low profit margin is understandable due to the company being a discount retailer, but it is also below the industry average. The earnings and revenue growth are well above the industry averages.

The current valuations for Costco show it is slightly overvalued with a trailing P/E of 33.98 and a forward P/E of 31.4. The price-to-sales ratio is at 0.85 and that is below the sector median. The price-to-book is at 9.87 and that is above the sector median. In other words, the various valuation metrics are mixed.

Overall the fundamental picture for Costco is better than average, by industry standards and in general. The earnings growth and the revenue growth are big positives as is the high ROE. Yes there are some negatives, but the positive indicators outweigh the negatives in my opinion.

Recent Pullback Has the Stock Hitting Two Layers of Support

I have to admit that the first thing that jumped out about Costco wasn’t the fundamentals, but rather the chart. A slow pullback over the last three months has brought the stock down to its 50-week moving average. There is also a trend line that connects the lows from the last two plus years. The trend line and the moving average are sitting right on top of one another.

The pullback has brought the weekly stochastic indicators down from overbought territory and they are now in oversold territory for the first time since late 2018. It has also brought the 13-week RSI down to the 40 area for the first time since the same time period—December 2018.

If we look back at time periods where Costco was trading near its 50-week moving average, and when the overbought/oversold indicators were below the 50 level, the stock has tended to rally over the ensuing few quarters. We see a strong rally from December 2018 through January 2020. The market meltdown last February and March caused the stock to drop down to the 50-week moving average again and then the stock rallied over 40% before the pullback started in November.

Changing Consumer Preferences Boosting Sales

When the virus hit the U.S. last year, analysts expected housing sales to get hit hard. But quite the opposite happened. Instead of seeing new home sales and existing home sales decline, we saw significant increases. The pandemic caused a shift in the demand for single family homes as consumers changed their preferences when it came to living arrangements. Instead of staying in the city and living in high rise apartment buildings, or multi-family homes, suburban areas have seen a huge jump in sales. There is also the matter of companies allowing employees to work remotely in greater numbers.

This huge shift in the housing market should help Costco going forward. Let’ face it, most apartments or condos don’t have the storage space of a single family home and many of the bulk products sold at Costco require some storage space. Buying a package of 40 rolls of toilet paper, 10 pounds of chicken breast, six pounds of salmon fillets, and giant boxes of cereal requires storage—not to mention a stand-alone freezer. As consumers move out to the suburbs and in to single family homes, many will discover the great savings the giant warehouse retailers offer.

Costco has already seen sales grow sharply over the past year and the housing shift should help that growth well in to the future. The company has nearly 800 stores operating around the world and the bulk of those stores (over 650) are in the United States and Canada. I have focused on the housing shift in the U.S. as a positive driver for Costco’s sales growth, but we are seeing housing demand grow all around the world and that should help the company’s international sales.

The Upcoming Report

Looking at the upcoming earnings report, Costco has beaten EPS estimates in seven of the last eight quarters, so I wouldn’t be surprised if the company beats once again. Even though the company has beaten estimates most of the time, it hasn’t always led to the stock moving higher. In fact, the last report in December came near the top and then the stock moved lower after the earnings report. Costco also beat estimates in September of last year and the stock rallied sharply in the weeks that followed.

One thing I took note of regarding the reaction to the last two earnings reports was where the overbought/oversold indicators were prior to the report. The stock was overbought in December and then proceeded to move lower. The stock was oversold, at least on the daily chart, in September and it proceeded to move higher after the report. The indicators could have been reflecting where investor sentiment was heading in to the report. In September, expectations may have been lower and then the company impressed investors. Investors may have been too optimistic heading in to the December report and that may have led to the move lower.

Looking at the current daily and weekly indicators, Costco is oversold in both timeframes. This may be a sign that investors are less optimistic this time around and that could make it easier for the company to impress investors. Personally I think the stock is primed for another move higher and can see the stock moving to a new all-time high within the next few quarters.

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