These Inflation-Fighting Retailers Are Winning

Last week, shares of Walmart (WMT) took off through the roof after the discount retailer announced earnings results that were better than investors’ expectations…

But there was a catch.

Walmart, known historically for its no-frills shopping experience and low prices, tends to attract buyers through their doors when things get tight with the family budget.

For example, the Great Recession that kicked off in 2008 guided Walmart’s prices higher by 35% as their revenue and earnings results reflected consumer’s shift to lower prices on everything from groceries to televisions.

By comparison, shares of Kroger (KR) declined 9% for the same period and Target (TGT) – announcing their quarterly results this week – dropped more than 40%.

As much as I like Walmart in this market, there’s another company that’s got a hold on the bargain pricing model that not too many people are thinking about… Costco (COST).

During 2008, Costco’s price dropped more than 20%, putting it in the middle of the pack when it comes to performance against other retailers during a recession, but something has changed since then.

Over the last decade, we’ve turned into bulk buyers. Whether you’re a family of one or seven, consumers have figured out that they can save money in the long run by taking advantage of larger quantities offered at lower prices.

From prime rib to salmon to toilet paper, we’re buying in bulk to lower our prices. Taking advantage of well-timed specials on those items needed and then filling the gap with short trips to Kroger or other retailers.

At the end of 2023 the Financial Health Network issued a report finding that 49% of respondents are buying items to fight inflation. They note that the strategy works when planned and executed well.

Here’s the catch: Costco is your “frenemy” when it comes to executing the strategy.

The company’s well-timed specials are nothing but good old-fashioned loss leaders to get you in the store. The end-cap displays are where they make the margins, margins that are consistent enough to make the stock feel like an annuity (it’s not, of course).

I’m a great example. My best planned trips to Costco, with a budget in mind, always end with me walking out with a smiling grimace on my face. The problem? Those darn end caps.

A set of garbage cans that they somehow knew I needed for my bathrooms. 22 Wi-Fi enabled smart switches that work with my whole home monitoring system that just felt right as a purchase. Those three plush dog toys for “The Stone-Cold Killer” – my dog’s nickname.

A trip for the budgeted items goes from $150 to $520 in the blink of an eye. I noticed the trend more than five years ago when it was a house of five that I was shopping for and decided that if I couldn’t beat ‘em, I’d join ‘em… I bought the stock then and continued to add to the position on large pullbacks.

You know this story, so what makes today different than last year in terms of adding Costco to your portfolio?

The pullback is why.

Last quarter, we saw the stock drop 10% after the company’s earnings report.

The report was in line with investors’ expectations. Earnings beat the market and revenue was just a little light, but the stock dropped 10%.

The reason… Costco’s management didn’t do one thing that many analysts expected would happen. They didn’t raise the price of our memberships.

Costco hasn’t raised the most basic expense in the store since 2017. Seven years ago, the cost of membership jumped 9% going from $55 to $60 for basic membership. They usually increase that membership price every 5.5 years or so, so we’re overdue.

The 10% drop was a punishment from Wall Street for not raising fees.

Consider this: Costco’s margins on products come in around 2.7%. Costco makes $4.6 billion in revenue each year from membership fees. That 4.6 billion is more than 70% of the company’s annual revenue.

That’s why Wall Street punished the stock last quarter. But it’s likely to change this quarter because there’s a new sheriff in town when it comes to the finances.

Costco’s CFO, Richard Galanti, stepped down from the position just a week after last quarter’s earnings report. The situation makes the timing of an increase in membership fees – a way to jump top line revenue by 10% or more – almost perfect. For the company, not you and me.

Costco’s investors appear wise to the timing as the stock has rallied 11% over the last two weeks.

cost stock chart

COST shares moved above their neutral 50-day moving average at the end of April, setting up a technical rally. Since then, the stock has traveled from $725 to $800, where it sits about a week away from the company’s next report.

We’re likely to see shares trade at this level due to the round-numbered resistance that $100 increments hold for stocks like COST.

A quick view of the current analyst price targets for COST shares see that the “crowd” appears to be behind on the stock. The average analyst price target sits at $779, below market price for the stock.  The increase of the membership dues will have analysts upgrading their revenue and price targets for the stock in the days after the earnings call. This adds fuel to the long-term rally of Costco stock.

We may see a small drop in share price given the “buy the news” move ahead of its earnings announcement, but I would be taking advantage of that drop to add to positions given the fact that this inflation fight is far from done.

For that reason, I target a short-term “buy” price of $775 along with a long-term target price of $1,000.

About the Author

Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.

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