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Stock Analysis & Ideas

Costco Stock (NASDAQ:COST): A Hedge Against a Potential Recession

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Shares of Costco are down this year amid bearish sentiment. However, the lower valuation presents a potential buying opportunity for this resilient business.

Shares of Costco Wholesale Corporation (NASDAQ: COST) were not spared the headwinds that have been blowing in the market since the beginning of the year. However, investing now would mean spending less cash, and a portfolio of financially-solid defensive stocks will act as a very effective shield against the next recession. Although COST could continue to fall in the coming period, I am bullish on the stock, as it will likely pay off over the long term.

The current market environment is one of great uncertainty as tensions between the global economic superpowers show no signs of abating. The United States and the European Union have been at odds with Russia since February 24, while the U.S. and China still disagree over Taiwan. Only the energy sector has seen a strong performance this year. As can be seen in the chart below, COST has been having a hard time recently.

Because Costco sells products and services that people can generally afford, regardless of financial market conditions or the economic cycle and its likely path, its stock price was expected to take a different stance than the market.

While the continued price decline worries shareholders, it also opens up an opportunity to consider buying this consumer-defensive company with solid fundamentals by taking advantage of lower prices compared to the recent past.

Costco Stock Looks Attractive Based on Technicals

Due to its recent decline, Costco looks attractive compared to its past. The current stock price of ~$466 per share is well below its 200-day moving average of $521.79. Additionally, the stock price, which results in a market cap of $206 billion, has fluctuated between the low of $406.51 and the high of $612.27 over the past 52 weeks of trading. That means the stock price falls into the bottom half of the range.

However, the same perception of attractiveness doesn’t emerge when comparing COST’s price-to-earnings and price-to-sales multiples to their respective medians in the industry (defensive retail). Costco has a P/E ratio close to 35x versus an industry median of 15.5x and a P/S ratio of about 0.9x versus an industry median of 0.50x.

For those ratios to approach their median, though, the stock price needs to fall quite significantly. Even assuming the strong pressure of an extended period of current headwinds, it’s unlikely that Costco’s share price could see such a reduction.

The stock could still fall a little further, but based on recent price patterns, it could already be close to a new low. The current trend looks poised to give way to a new rally once the market becomes aware of the company’s characteristics as a resilient business, which could help hedge against the start of a likely new recessionary phase.

Costco’s Resilient Business is a Recession Hedge

Headwinds are gripping Costco, making traders forget about this stock’s main attribute as a resilient company. However, with nearly all sectors succumbing to the next recessionary headwind, traders will seek refuge in steadily rising sales of staples, including Costco. Costco’s earnings per share (EPS) are expected to rise more than 10% to $14.57 in Fiscal 2023, and sales are expected to rise by 7.8% to $244.6 billion, showing its resiliency.

The Federal Reserve’s announcement on Wednesday that it would hike interest rates by another 75 basis points reinforced the signal that Jerome Powell wants to send to the market.

Consumption and investments must be scaled back for inflation to move further toward the 2% target of price stability and maximum labor utilization.

This inflation is not caused by factors related to the demand for goods and services but rather by factors beyond the control of the Federal Reserve. These are rising energy bills and skyrocketing military spending because of the war in Ukraine. Thus, the aggressive restrictive policies of Jerome Powell and his associates will likely only be able to wipe out inflation through an economic downturn.

However, during an economic recession, there are goods and services that people will buy anyway because they meet necessities that they cannot do without.

That’s why Costco offers an efficient tool to weather the headwinds of an economic downturn with its diverse portfolio of consumer products and services.

Thanks to its 838 member warehouses at the end of August 31, 2022, the company continues to strengthen its sales figures. In August 2022, Costco’s total net revenue came in at $17.55 billion, up 11.4% year-over-year.

For the final quarter of Fiscal 2022, ended August 28, 2022, total revenue was $70.76 billion, representing 15.2% year-over-year growth.

For Fiscal 2022, total net revenue was $222.7 billion, up nearly 16% year-over-year. This growth rate is well above its five-year average of 11.5%, creating strong upside potential for the share price in the upcoming periods. Also, in Fiscal 2022, same-store sales grew year-over-year in all regions (with the U.S. up 15.8%, Canada up 15.2%, overseas sales up 6.6%), and online sales grew by 10.1%.

Costco’s Balance Sheet is Solid

Essentially, the following two financial metrics make for a solid balance sheet. Its Altman Z-Score of 6.9 implies essentially no chance of bankruptcy in a few years. For beginners, any value between 1.8 and 3.0 represents a moderate risk, while a value below 1.8 represents an increased risk of near-term bankruptcy.

Also, Costco’s interest coverage ratio above 50x also indicates sound financial conditions, as a score above 1.5 means that the company is able to service all loans and meet liabilities on time. The ratio is calculated as operating income divided by interest expense.

As of August 28, 2022, the balance sheet reported cash on hand of $11.05 billion against total debt of $9.04 billion, which includes current and non-current debt and long-term lease liabilities.

Is COST Stock a Buy, According to Analysts?

On Wall Street, Costco Wholesale Corporation has a Strong Buy consensus rating based on 17 Buys, three Holds, and zero Sell ratings assigned over the past three months. At $566.53, the average COST price target implies upside potential of 21.2%.

Conclusion: Consider Costco Stock to Beat a Recession

Harsh economic conditions have plunged the stock market into a bear market, and Costco wasn’t spared. The stock is now much cheaper, which may offer a buying opportunity for a company that could soon serve as a strong hedge against a recession, likely to arise because of continued aggressive monetary policy.

Disclosure

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