- Bernstein downgraded Costco stock to “underperform” due to the company’s high valuation and competitive pressure.
- Jim Cramer suggests a “buy” on the downgrade.
- Costco stock closed 1.6% lower on Wednesday.
Why did Costco stock fall?
Costco (COST) stock closed 1.6% lower on Wednesday following A.B. Bernstein’s downgrade. Bernstein analyst Brandon Fletcher downgraded Costco shares to “underperform” from “market perform” due to its high valuation. The analyst expects aggressive competitive activity to impact Costco’s membership base and hurt its margins. Despite the downgrade, Bernstein increased its target price to $230 from $220.
Speaking on the downgrade, CNBC’s Jim Cramer suggested that investors “buy” Costco stock on a pullback. Cramer stated that Costco stock was “due for a pullback” given its strong run since the beginning of the year. Costco shares have risen 41.3% on a year-to-date basis as of Thursday. However, Cramer said, “I have no doubt that Costco’s worth buying into weakness.”
We think that the uptrend in Costco stock calls for some profit-booking. However, the downside seems limited. As a result, a pullback presents an opportunity to become constructive on the stock. Costco has continuously produced industry-leading comps growth despite the higher competitive activity. Also, the company’s bottom line increased at a remarkable pace—about 19% in the past nine quarters on average.
We expect the comps growth to moderate a bit due to tough year-over-year comparisons. However, Costco will likely sustain the momentum and outpace its peers, which would limit the downside.
Earlier this month, Oppenheimer downgraded Costco stock to “perform” from “outperform.” Analyst Rupesh Parikh cited the company’s high valuation and tough comparisons for the downgrade. However, the analyst raised the target price to $300 from $295.
Costco’s valuation and target price
Costco trades at 33.7x its fiscal 2020 estimated EPS of $8.55, which is expensive. Also, the stock trades at a significant premium to its peers. Notably, Costco trades at 17.9x its next 12-month EV-to-EBITDA multiple, which is roughly double the peer group average of 9.0x.
However, Costco has a premium valuation for a good reason. The retailer has outperformed peers with its sales and earnings growth rate. We think that Costco could sustain mid to high-single-digit comps growth during the holiday season. Holiday sales forecasts set a bullish tone. We think that Costco, Target (TGT), and Walmart (WMT) could gain the most. Costco’s high membership renewal rate, expanded offerings, and price investments will likely draw higher traffic.
Costco’s domestic sales have been growing at a significant pace. The company’s comps in the US have grown more than 6% in the last three months. Costco increased 6.4% in August, which reflected its higher traffic and ticket size.
While Costco could benefit from its value pricing, its peers including Walmart and Target, could gain from expanding digital fulfillment options. Walmart’s online grocery pickup services are now available in more than 2,700 stores. The company offers same-day grocery delivery through 1,100 stores. Meanwhile, Target’s expanded same-day delivery through Shipt and Drive Up will likely boost its traffic.
We think that Costco’s high valuation and higher competitive activity could limit the upside in its stock.
Among the analysts covering Costco stock, 16 recommend “buy,” 12 recommend a “hold,” and one recommends a “sell.” Analysts’ consensus target price of $288.88 is roughly on par with its closing price on Thursday.