Options Trade of the Week
Costco Wholesale Corporation (NASDAQ:COST) Calls      
Monday, October 06, 2014

**OPTIONS TRADE OF THE WEEK: Buy the COST Apr 2015 130.000 call (COST150417C00130000) at or under $3.50, good for the day. Place a protective stop limit at $1.40 and a pre-determined sell at $6.50.

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by Ian Harvey

October 06, 2014

Introduction

**Costco Continues Its Upwards Momentum! **

Costco Wholesale Corporation (NASDAQ: COST), with its subsidiaries is engaged in the operation of membership warehouses in the United States and Puerto Rico, Canada, the United Kingdom, Mexico, Japan, Australia, and through majority owned subsidiaries in Taiwan and Korea, is scheduled to announce the results of its fiscal fourth quarter before the market opens on October 8. Analysts have forecast the company will post quarterly earnings of $1.51 per share, up from $1.40 during the same period last year. The stock has gained 5.7% in 2014.

Technical Oulook

Shares of Costco Wholesale opened at 125.79 on Friday. Costco Wholesale has a one year low of $109.50 and a one year high of $127.78. The stock’s 50-day moving average is $123.7 and its 200-day moving average is $117.5.

The company has a market cap of $55.133 billion and a price-to-earnings ratio of 27.92.

Earnings

Costco has performed OK this year, and with consumer confidence on the rise, retailers are likely to have performed well during the summer months, but Costco does not have the best earnings track record. The company reported earnings below the consensus estimate each of the last four quarters, but despite this fact, the stock has not really been very volatile. In fact, following the last earnings miss on May 29, the stock actually moved higher in reaction to better than expected revenues and a 5.6% increase in revenues from membership dues.

Plenty of Positives

• Costco's same store sales have been rising consistently throughout much of 2014, outperforming Wal-Mart's (NYSE: WMT) Sam's Club and Supercenters. One advantage that helps Costco consistently beat its rivals is store location. The company's stores are located in more affluent neighborhoods, thereby targeting customers with greater disposable income who can buy in bulk.

• The company also focuses its merchandise mix to include must-have staples and timely seasonal items to keep its customers coming back.

• Its private label, Kirkland Signature, is known for its quality and value. Since Kirkland can only be found at Costco, customers are likely to become more loyal to the retailer in order to continue purchasing a trusted brand.

• Customer loyalty has helped grow revenue from membership fees by nearly 8% annually.

• Costco also enjoys unusually low employee turnover compared to other retailers, likely the result of higher than average wages and benefits. Low turnover results in higher productivity and reduces the expense of constantly hiring and training new employees. This helps to mitigate the expenses related to higher compensation for employees.

Future Growth

• Costco's revenue from membership fees consistently outpaces its overall profit. In other words, increasing membership fees is the key driver to future growth – where membership fee revenues are growing at a steady pace -- roughly 8% per year.

There's little doubt Costco will continue to grow its footprint, membership rolls, and fees derived from those rolls. Not only is it expanding in the U.S., but Canada, Mexico, Japan, the U.K., Korea, and Australia.

• According to Bloomberg, Mastercard Inc (MA) and Capital One Financial Corp. (COF) have struck a deal with Costco Wholesale Corporation to issue a co-branded credit card in Canada after the retailer’s contract with American Express Company (AXP) ends this year.

The credit card is also expected to serve as a membership card for the warehouse retailer, and all other MasterCard credit cards will also be accepted by Costco at its Canadian stores. The management of Capital One said the partnership with Costco is a part of the company’s strategy to continue growing its credit-card portfolio in Canada.

Analysts Opinions

Costco Wholesale Corporation moved higher after Oppenheimer raised its price target from $105 to $120 and reiterated its Perform rating last Friday.

Analysts, Brian Nagel and Erica Miller, listed five factors in their Friday report that “speak to the longer term prowess” of the Costco operating model:-

1. robust store volumes,

2. success in operating outside the US,

3. new unit growth potential in the US and overseas,

4. strong cash flow to support buybacks and

5. dividends and merchandising disciplines which drive traffic and defend against competitors.

The report concluded that the Nagel and Miller “look very favorably on the operating prowess of COST and view the company's substantial recurring membership income as one of the most powerful underlying financial gems in the Retail sector.” Recent weakness in EPS growth should soon “give way to improving trends.”

The company has also been the subject of a number of other research reports:-

• Analysts at Jefferies Group reiterated a “hold” rating on shares of Costco Wholesale in a research note on Thursday, September 25th. They now have a $115.00 price target on the stock, up previously from $104.00.

• Separately, analysts at Citigroup Inc. initiated coverage on shares of Costco Wholesale in a research note on Monday, September 15th. They set a “buy” rating and a $150.00 price target on the stock.

• Finally, analysts at Zacks reiterated a “neutral” rating on shares of Costco Wholesale in a research note on Wednesday, September 10th. They now have a $132.00 price target on the stock.

Four investment analysts have rated the stock with a hold rating, ten have assigned a buy rating and one has given a strong buy rating to the stock. The stock has an average rating of “Buy” and a consensus target price of $154.21.

Summary

• Costco is scheduled to report F4Q earnings on 10/08/2014 prior to the market opening.

• Customer loyalty and low employee turnover have helped the company outperform its key rival this year.

Conclusion

While the company's four consecutive earnings misses raises concern, it is believed that rising consumer confidence may finally allow the company to break its negative streak and post earnings that are, at the least, in-line with analyst estimates. The stock has been trending higher since the start of summer, and the stock should maintain an upward trend through the remainder of the year.

Despite increasing pressure from its competitors, Costco has a satisfied, productive workforce and loyal membership base. These two factors are huge positives for the company and may help trump the increased pricing pressure that Costco is facing from competitors now and in the future.

Therefore, based on the facts above the following options trade is recommended…..


**OPTIONS TRADE OF THE WEEK: Buy the COST Apr 2015 130.000 call (COST150417C00130000) at or under $3.50, good for the day. Place a protective stop limit at $1.40 and a pre-determined sell at $6.50.


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