12 Sep

Costco: Why Oppenheimer Downgraded Its Stock

WRITTEN BY Amit Singh
  • Oppenheimer downgraded Costco stock due to the company’s high valuation.
  • The stock closed 2.1% lower.

Oppenheimer downgraded Costco (COST) stock on Wednesday. Oppenheimer analyst Rupesh Parikh downgraded the stock to “perform” from “outperform” due to the company’s high valuation. The analyst expects little upside in the stock due to the company’s high valuation and tough YoY (year-over-year) comparisons. Costco shares closed 2.1% lower following the downgrade.

Despite the downgrade, Oppenheimer increased its target price on the stock to $300 from $295.

Costco stock trades at a premium

Costco shares trade at 34.0x its fiscal 2020 estimated EPS of $8.56, which looks expensive considering the projected EPS growth of about 6% during that period. The company is also trading about 24% higher than its historical average multiple of 27.4x.

The strong run in Costco stock has driven its valuation higher. The stock has risen 42.7% on a YTD (year-to-date) basis as of Wednesday. The uptrend in the stock is due to the company’s stellar comps growth in the past several quarters.

Costco continues to produce industry-leading comps growth despite more competitive activity. Also, the company’s bottom line registered remarkable growth in the last nine quarters. On average, Costco’s EPS rose about 19% in the past nine quarters.

Besides a stellar financial performance, the expectation of a special dividend and the overwhelming response in Costco’s China store drove the stock higher.

In comparison, Target (TGT) and Walmart’s (WMT) valuations also increased. However, both of the companies’ stocks trade at a lower multiple than Costco. Target and Walmart stocks trade at forward EPS multiples of 17.1x and 23.3x, respectively.

What’s on the horizon?

We expect Costco’s comps growth rate to moderate a bit. The company is up against tough YoY comparisons. Meanwhile, the company’s EPS growth will likely decelerate and limit the upside in the stock. However, strong domestic sales despite tough comparisons indicate that Costco’s comps could continue to rise at a mid-single-digit rate. Mid-single-digit comps growth looks impressive given the tough comparisons and cushion against the downside.

Costco’s value pricing and square footage expansion will likely support its top line. Meanwhile, tightened overhead costs could support Costco’s bottom line.

The company’s unique business model and value proposition make it somewhat immune to more competitive activity. Costco’s membership renewal rate remains high despite lagging peers on the digital front.

Amazon is reducing the delivery time for its Prime members to one day. Meanwhile, Target is gaining from the expansion of its same-day delivery capabilities. Walmart has significantly expanded its grocery pickup and delivery services, which drove its traffic. On Wednesday, Walmart announced that it will expand its grocery delivery membership option to 1,400 stores. Under the program, customers can get unlimited grocery delivery for a yearly payment of $98 or $12.95 monthly.

Analysts’ target price 

Among the 29 analysts covering Costco, 16 recommend a “buy,” while 13 recommend a “hold.” Analysts’ target price of $287.54 is about 1% lower than its closing price of $290.69.

As of this writing, Market Realist Amit Singh doesn’t hold a position in any of the securities mentioned above.

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