Costco’s 9% Comp Is A Strong Buy

Stay At Home Trends Will Linger Long Into The Future

Retail has been a big spotlight during the pandemic for more reasons than one. The sector is about as diverse as it can be, ranging from staple items folks need every day to discretionary items we just don’t have to have. What is becoming more and more clear is that, while this pandemic continues to impact our society, the discretionary retailers are suffering while those offering staple items are not.

Nothing makes this more evident than the comp-store figures released by Costco (COST). The members-only discount shopping warehouse says comps in March surged more than 12.25% adjusted for fuel and FX. Including fuel, whose price has plummeted in the last month, comps are still up a whopping 9.6% as sales accelerate from the previous quarter.

It’s The Virus, But These Trends Have Legs

The virus pandemic is responsible for the surge in Costco sales. The shift to stay-at-home and pantry-loading has food, paper, and household supplies in high-demand. The good news for Costco is that these trends are not going to end soon. Even if the pandemic climaxes this month, and a slow reopening starts in April we’ll still be social-distancing long into the future.

This morning Bill Gates gave some deep insight into what we might expect from an economic recovery once it gets started. In his view, it will be well into 2021 before things get back to any kind of normalcy. Long before then, we can expect to see essential businesses reopen but under new protocols. Non-essential activities like spectator sporting events, festivals, etc will be much longer in their return. The bottom line is that staples-selling businesses like Costco should expect to see increased consumer demand well into 2021.

Growth In A No-Growth Environment

What Costco and its peers are able to produce in these days that makes them so much different from virtually every other business is that it is able to produce real growth. The consensus for Costco’s fiscal 3r quarter, the calendar 1st, is EPS growth in the range of 10%. Based on the comps it looks like this figure will be easily met. Looking beyond that, Costco is expecting to post EPS growth in the range of 7% for the year while the broad market’s shrinks.

Costco’s growth is not limited to its exposure to pandemic-inspired buying. The company has been producing regular growth for the last decade with a CAGR in the high single-digits. The consensus for the next decade is for much of the same with revenue and EPS growth peaking near 20% over the next 5 years.

In terms of the analysts, the average rating is a strong buy. Out of the 32 sell-side analysts covering the stock 18 are bullish, 12 very bullish, with only 2 bears. Over the last 90 days, the consensus has been steadily improving although the price target has held fairly steady.

At $318.30 that leaves only 5% upside for new investors but there is a caveat. With pandemic-driven traffic fueling sales, it’s very possible Costco will outperform the consensus this quarter. In that scenario, the analysts may begin raising their rating and targets, an event that will help drive future capital gains.

Dividends, Dividends, Dividends

I can’t say enough about how important dividends and dividend safety are in these times. Costco’s dividend may not yield much, about 0.85% at today’s share prices, but it’s a safe and growing dividend. The company is paying only 30% of earnings which leaves quite a bit of free cash flow available for future increases. And future increases are expected. Costco is well on the way to Dividend Aristocrat status and comes with a 15% distribution CAGR to boot.

The company is expected to deliver another distribution increase next month when it reports earnings so there are other catalysts for gains. Stocks with a history of dividend increases tend to see their share prices rise as the distribution rises, one of the many reasons I favor dividend-growth stocks.

The Technical Outlook: This Is What Outperformance Looks Like

A look at the Costco chart makes it clear the company was not immune to the coronavirus. The silver lining is that, once you do the math, you will see that Costco fell barely more than 15% compared to the S&P 500’s 35% correction. That’s quite a bit of outperformance and compounded by the rebound which has Costco up another 21%. That move puts Costco’s price at -8% from the pre-correction high compared to -17% for the S&P.

In terms of price action and technical outlook, Costco looks bullish but there is a caveat. The stock is within a trading range that began last September and may constrain prices in the near-term. The upshot is that price action is near the bottom of the range and moving higher. The top of the range, near $330, represents a move of 10% without the dividend. If (when) price action is able to break out to new highs a sustained rally is likely to form. Based on the previous move that rally could add another $100 or 33% to share prices by the end of 2021.