18 Jul

Is the Expectation of a Special Dividend Driving Costco Stock?

WRITTEN BY Amit Singh

Why a special dividend could be around the corner

Costco (COST) stock has generated stellar returns so far this year and is up 38.2% on a YTD basis. Meanwhile, its stock has increased by 84% in the past couple of years. Despite the strong gains, Costco stock could rise further, thanks to the optimism around a special dividend.  Analysts and investors are expecting Costco to announce a special dividend in 2019.

Is the Expectation of a Special Dividend Driving Costco Stock?

Costco’s strong financial performance, reflecting industry-leading comparable sales and double-digit EPS growth has led to strong cash pile. At the end of the third quarter of fiscal 2019, Costco’s free cash flows stood at $2.1 billion. We believe Costco’s robust sales and the easing of pressure on margins will allow the company to announce a special dividend. Costco last paid a special dividend of $7 in May 2017.

Stocks of big-box retailers including Costco, Target (TGT), and Walmart (WMT) have been scaling new highs. Their ability to defend and grow market share and investments in growth are leading to higher traffic, and in turn, higher comparable sales. Earlier, Goldman Sachs initiated coverage on these big-box retailers with a “buy” rating.

We expect Costco to continue to post industry-leading comparable sales in the coming quarters. The retailer’s loyal customer base and investment in price to widen the value gap with peers will drive traffic. Costco’s membership renewal rates are at 91% in the US and Canada.

Should investors wait for a pullback in Costco stock?

We are impressed with Costco’s financial performance and expect it to sustain momentum in the coming quarters. However, we don’t like its current valuation. Also, Costco’s EPS growth rate is likely to moderate as it faces tough comparisons in the coming quarters.

Costco is trading at a forward PE multiple of 33.9x, which is more than double Target’s forward PE multiple of 14.5x. Also, it’s trading about 26% higher than its historical average of 26.9x.

Analysts expect Costco’s adjusted earnings to increase by about 6% in fiscal 2020. Notably, we expect Target to offer similar growth but at a lower valuation multiple. We believe a pullback in Costco stock could be in the offing.

Analysts maintain a “buy” on Costco stock. Moreover, Raymond James increased its target price on Costco stock to $300 from $260 on July 18. However, analysts’ consensus target price of $263.96 implies a downside of 6.2%.

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