Stock Analysis & Ideas

Costco Stock: Great Value amid Retail Bloodbath

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Costco stock has fallen into a bear market amid broader weakness across retail names. With earnings on tap, can the big-box retailer begin to find its feet?

Costco (COST) stock has dropped significantly recently, following in the footsteps of most other retail plays that have fallen so drastically out of favor. Currently, down around 28% from its all-time high, the big-box retailer now finds itself trailing the S&P 500 (SPX) thanks to the recent souring of retail stocks. Nonetheless, I remain bullish on COST stock.

Today, Costco is slated to release its third-quarter results. Action in shares of Costco suggests the post-earnings reaction could have the potential to be really ugly. Inflation has weighed heavily on even the most resilient of retail behemoths.

Undoubtedly, the recent quarterly flop of Walmart (WMT) helped fuel the recent slide in retail names across the board.

Though Costco has strong managers running the show, few think the big-box retail powerhouse can buck the trend. Even if it can’t impress for the third quarter, the fundamentals still look incredibly sound, even with the bleak macro outlook.

Thus far, 2022 has proven to be a year to not chase stocks going into their earnings. Even firms that manage to pull off top- and bottom-line beats have struggled to sustain a rally. Indeed, there’s a lot of incentive to sell ahead of quarterly releases this time of year.

With so much focus on forward-looking guidance and how a firm will fare as we inch closer to a potential downturn, it’s not a mystery as to why the buyers have vanished. It’s a startling time to be an investor, with the S&P 500 on the verge of revisiting bear market territory.

Though Costco faces medium-term headwinds (which company hasn’t been swindled by inflation these days?), it’s hard not to be bullish on the stock after a painful plunge going into earnings.

The long-term fundamentals are still intact, and it’s the company’s strong value proposition will help it persevere through what could be an ugly next 18 months for the economy.

Costco: An Inflation Fighter Through the Eyes of Consumers?

These days, it seems like inflation isn’t leaving, even as the economy shows signs of weakening.

Though the consumer is still somewhat strong, with plenty of savings built up during the earlier innings of the pandemic, the “wealth effect” could cause sentiment to sink rapidly.

The recent damage done to the stock market, the rapid rise of inflation, and the growing anticipation of a recession could prevent many households from digging into their savings. Such factors could make consumers feel poorer, even if the Fed manages to pull off a soft landing. Given the inflation shock, it is hard to gauge our loss of purchasing power.

If anything, consumers could squirrel away even more cash in preparation for the hard times that are here and the harder times that could be on the horizon.

Costco isn’t immune from the forces hurting retail stocks right now. Inflation is likely to take a step out of Costco’s stride for the time being. Still, I view Costco as a firm that will stay resilient because of its strong value proposition.

When inflation rises, many of us are bound to experience sticker shock at the grocery store. It’s only natural to resist the price increases by any means possible. If you don’t shop at Costco or Walmart, it’s hard to avoid paying more for less.

Higher prices and the phenomenon of “shrinkflation” (same price for less product) are deflating for many consumers. With Costco’s reputation for offering incredible value for its members, the company finds itself positioned to take more share in the retail space. Consumers are hungry for great deals, and arguably, Costco has some of the best deals in town.

As inflation lingers, expect Costco’s margins to be dragged lower. Still, sales should stay robust. With great managers and trusted, low-cost private-label brands, I think Costco is in better shape than almost any other retailer to move past the retail storm clouds moving through the markets right now.

Wall Street’s Take

Turning to Wall Street, COST stock comes in as a Strong Buy. Out of 19 analyst ratings, there are 16 Buy recommendations and three Hold recommendations.

The average Costco price target is $594.84, implying upside potential of 35.2%. Analyst price targets range from a low of $500.00 per share to a high of $678.00 per share.

The Bottom Line on Costco Stock

Costco stock could endure a tough crowd after pulling the curtain on its earnings results. Still, the company’s long-term fundamentals should not be clouded by nearer-term headwinds.

After falling into a bear market, Costco stock is starting to look cheap, given its premium traits. At ~30x times forward earnings, Costco stock trades at a discount to its five-year historical average forward P/E of around 33x.

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