Options Trade – Costco Wholesale Corporation (COST )
Wednesday, October 03, 2012

COST stock should be able to bounce off the $100 mark!

**OPTION TRADE: Buy the COST Jan 2013 105.000 call (COST130119C00105000) at or under $1.50, good for the day. Place a protective stop limit at $0.60 and a pre-determined sell at $2.50.

by Ian Harvey

October 03, 2012

Introduction

Winter is approaching whether you like it or not, and if you live in a cold-weather state, it could be much more depressing.

Now is the time to stock up on food and supplies so you’ll have to venture out less when the cold weather strikes. To be able to do that will take money that you might not have budgeted for. Here is a trade idea that might allow you to do both … plus get some free samples.

Therefore, Costco (Nasdaq: COST) will be the place to cater for these needs. Also, COST hit a new all-time high last week, which is extremely enlightening considering that longtime CEO Jim Sinegal retired back in January. If there were any doubts about an orderly succession at the time, they don't exist now. Costco has gone on to deliver better-than-expected quarterly results in the warehouse club's first two quarters under new helmsman Craig Jelinek, and it will get a chance to stretch that streak up to three when Costco reports next week.

Shares of Costco have climbed higher than 20% so far this calendar year, so the warehouse club should be in good shape.

About Costco

Costco Wholesale Corporation (Nasdaq: COST) operates membership warehouses that offer a selection of branded and private label products in a range of merchandise categories in no-frills, self-service warehouse facilities.

Costco Wholesale Corporation was founded in 1976 and is based in Issaquah, Washington. The company was formerly known as Costco Companies, Inc. and changed its name to Costco Wholesale Corporation in August 1999.

The company’s product categories include candy, snack foods, tobacco, alcoholic and nonalcoholic beverages, and cleaning and institutional supplies; appliances, electronics, health and beauty aids, hardware, office supplies, cameras, garden and patio, sporting goods, toys, seasonal items, and automotive supplies; dry and institutionally packaged foods; apparel, domestics, jewelry, house wares, media, home furnishings, and small appliances; meat, bakery, deli, and produce; and gas stations, pharmacy, food court, optical, one-hour photo, hearing aid, and travel. It also provides business and gold star (individual) membership services.

As of July 5, 2012, the company operated 605 warehouses, including 438 in the United States and Puerto Rico, 82 in Canada, 32 in Mexico, 22 in the United Kingdom, 13 in Japan, 8 in Taiwan, 7 in Korea, and 3 in Australia. It is also involved in electronic commerce businesses through its Websites, costco.com in the United States and costco.ca in Canada.

Of revenue, 72.5% came from the United States, 15.7% from Canada, and the remaining 11% from the rest of the world. As of May 6th, it has a total fee-paying member population of 66,500,000. Costco operates its wholesale operations with a faster turnover than Wal-Mart (WMT) and its average sales per square foot have steadily increased over the past 10-year period:

Costco has successfully established its private "Kirkland Signature" brand within its stores; and while the brand makes up only 15% of items carried, it now makes up about 20% of sales. Costco is rated by Interbrand to have the 15th most valuable retail brand, after Dollar General (DG).

And anecdotally, Costco has one store which did an incredible $400 million of business last year -- $0.4 billion at one location.

The Rationale Behind the Options Trade

Most people probably are familiar with Costco. As mentioned above, the company operates more than 600 wholesale warehouses around the world, but primarily in the U.S. Many analysts think COST is the cream of the crop when it comes to wholesale retail. The company is profitable and growing. Costco plans to open six additional warehouses in 2012, and the company’s revenue has grown much faster than its P/E ratio in the past several years.

Costco Wholesale Corporation has a market cap of $43.3 billion and is part of the retail industry. The company has a P/E ratio of 28, equal to the average retail industry P/E ratio and above the S&P 500 P/E ratio of 17.7. Shares are up 20.2% year to date as of the close of trading on Monday.

Analysts’ Opinions

Currently there are 12 analysts that rate Costco Wholesale Corporation a buy, three analysts rate it a sell, and seven rate it a hold.

Costco had its price target upped by Stifel Nicolaus from $100.00 to $107.00 in a research report sent to investors on Tuesday morning. The firm currently has a buy rating on the stock.

COST has been the subject of a number of other recent research reports:-

• Zacks reissued their neutral rating on shares of Costco (NASDAQ: COST) in a report released on Friday. Zacks currently has a $104.00 target price on the stock.

• Analysts at Bernstein reiterated an underperform rating on shares of Costco in a research note to investors on Thursday, September 27th. They now have a $94.00 price target on the stock.

• Separately, analysts at Bank of America raised their price target on shares of Costco from $98.00 to $110.00 in a research note to investors on Wednesday, September 26th. They now have a buy rating on the stock.

• Analysts at Argus raised their price target on shares of Costco from $100.00 to $110.00 in a research note to investors on Wednesday, September 19th. They now have a buy rating on the stock.

• Analysts at Piper Jaffray reiterated an overweight rating on shares of Costco Wholesale in a research note to investors on Tuesday, September 18th. They now have a $112.00 price target on the stock.

• Finally, TheStreet Ratings rates Costco Wholesale Corporation as a buy.

Valuation

Costco stock has moved from about $82 in May to where it is currently trading. COST found resistance at $100 earlier in September and finally was able to move higher. This past week, Costco stock has drifted back to that area, which should act as support and should be able to bounce the stock higher again. This also allows us to enter the option trade at a lower cost factor.

If we look at the free-cash-flow for the nine-month period ending May 6th, 2012, and then annualized it, we see that Costco is on track to achieve a FCF rate of about $1,900 million this year (which is, incidentally, identical to the amount earned in 2011).

With a market capitalization of $43.6 billion, Costco's P/FCF would be 22.9; which works out to a free-cash-flow yield of about 4.3%. Given its stable position, its membership model, and that it has been growing FCF over the years at some 15% annually, such valuations are not unjustified. Further, the valuation is quite comparable to other discounters.

Earnings Report

The company is expected to announce earnings on Oct. 10. Because of that, there should be a rise in implied volatility heading into earnings, which should increase the call’s premium.

The company's strengths can be seen in multiple areas, such as its growth in earnings per share, increase in net income, revenue growth, good cash flow from operations and increase in stock price during the past year.

Costco is entrenched, profitable, and growing. It is best in class when it comes to wholesale retail.

Therefore, with the drop in share price, and based on the facts above the following options trade is recommended…..


**OPTION TRADE: Buy the COST Jan 2013 105.000 call (COST130119C00105000) at or under $1.50, good for the day. Place a protective stop limit at $0.60 and a pre-determined sell at $2.50.


”Success is simple. Do what's right, the right way, at the right time.”


Option Tip for your Success!
Options traders are not successful because they win.
Options traders win because they are successful.



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