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Target and Costco: What’s Next after a Solid August?

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Broader markets took a hit in August as the intensifying US-China trade war remained a drag. Moreover, recession fears stemming from the yield curve’s inversion further dragged the index down. The S&P 500 fell about 2% in August. Amid pessimism, Target (TGT) and Costco (COST) stocks generated stellar returns. Their shares rose 24% and 7%, respectively, in the month.

Target stock is up 62.0% on a YTD (year-to-date) basis as of August 30. Meanwhile, Costco stock is up about 45% YTD as of the same date.

While Target stock benefited from its stellar second-quarter performance and upbeat guidance, Costco gained from sustained momentum in its comps. Costco stock also got a boost in August from the overwhelming response to its first China store.

Higher consumer spending fueled by low unemployment and interest rates and higher wages is driving retail sales. Moreover, digital transformation and value pricing will further drive the traffic and comps of these retailers.

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For instance, Target’s digital transformation is driving its growth. The expansion of its same-day delivery services, including drive-up and store pickup, is pushing its comps higher. A focus on merchandising and an accelerated pace of store remodeling are further supporting its top line growth. Besides robust sales, Target’s margin improvement is also an encouraging sign.

Meanwhile, Costco continues to benefit from its investments in price and its expanded assortments. The retailer continues to widen the value gap with its peers, which is driving robust traffic.

Why Target and Costco have sustained momentum

Wells Fargo analyst Ike Boruchow remains cautious about holiday sales. CNBC reported that the analyst expects warm weather, a shorter a holiday calendar, and lower tourist spending to hurt holiday sales. However, retailers such as Target, Walmart, and Costco are expected to sustain momentum in the second half of the year.

Target expects its comps to sustain momentum and register growth of about 3.4% in the back half of 2019. Target’s comps growth guidance looks impressive, as the retailer will be up against tough YoY comparisons. Target’s comparable sales rose by more than 5% in the second half of 2018.

We expect expanded delivery options and compelling brands to drive Target’s comps in the second half of 2019. Meanwhile, its bottom line is likely to benefit from higher underlying sales, margin expansion, and share repurchases.

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As for Costco, its high membership renewal rates and value pricing indicate that the retailer will continue to outperform peers with its comps growth rate. Costco’s membership renewal rates were very high at 90.7% in the US and Canada at the end of the third quarter of fiscal 2019. Meanwhile, worldwide renewal rates were 88.3%. Costco is slowly expanding its e-commerce offerings, which should further support its top line growth. Its bottom line is expected to gain from robust comps growth.

What the consensus estimates indicate

Analysts’ consensus estimates indicate that Costco is likely to outperform its peers in the coming quarters. Analysts expect Costco’s top line to continue to grow at a high-single-digit rate in fiscal 2020. Robust comps growth and high membership fee income are expected to support the retailer’s top line growth. Its bottom line is also expected to mark strong growth despite tough comparisons.

As for Target, analysts expect its sales to continue to benefit from improved comps. Meanwhile, Target’s bottom line is likely to mark stellar growth in the back half of 2019. Furthermore, analysts expect Target’s adjusted EPS to sustain momentum and mark high-single-digit growth in 2020.

The majority of Wall Street analysts maintain “buy” ratings on both Costco and Target.

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