“Cut-to-the-Chase” Recommendations
- Week Beginning September 26, 2016 -

by Ian Harvey

IMPORTANT NOTE: There is no stop-loss or pre-determined sell price recommended – this is left to the discretion of the individual trader.

Tuesday, 27th September, 2016
Costco Wholesale Corporation (NASDAQ:COST) Puts

**OPTION TRADE: Buy the COST OCT 21 2016 145.000 put at approximately $1.45. Sell price is left to your own judgment.

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 report its fiscal fourth-quarter results on September 29 after the market close. Analysts forecast earnings of $1.73 per share, in-line with the same period last year.

Costco has had a tough go of it lately. The stock has been trending sharply lower over the last month, and shares are currently down 5.3% on the year. Costco’s sales growth has started to slow, which is a big concern for the company moving forward. A big reason for the concern is that for years Costco enjoyed same store sales growth in a range of 6% and 7%, but that figure has fallen to around 4% in recent months, in part a result of the strong dollar that has led to deflation in many product categories.

For the 52-week fiscal year which closed Aug. 28, the warehouse club reported net sales of $116.1 billion, a 2% increase from the $113.7 billion reported last year. Those numbers aren't awful, but they hint at weakness.

When it comes to comparable sales, the numbers weren't great either, though they look better after adjusting for falling gas prices and foreign currency exchange. After the adjustment, the increase in the United States jumps from 2% to 3% and the Canada numbers go from a 3% decline to an 8% gain. International numbers were similar, moving from a 3% dip before adjustment to a 4% positive move after. Still, overall, before the adjustment, 52-week growth was 0%, and after it was only a 4% gain.

Those are mediocre results, which point to things that could hurt Costco's stock price going forward.

The company recently started offering new credit cards with Citibank, and is still suffering from some initial problems. Analysts see very little earnings growth this year.

Why Costco?

Costco is facing some major headwinds this year. For two-consecutive years deflationary pressures have been negatively impacting on the company's results. Whilst cheaper prices are great for shoppers, it isn't great for its shareholders.

Revenue growth has been slowing over the last few years. The current consensus estimate is for earnings per share to come in at $5.29, just two cents higher than last year's earnings per share of $5.27. Whilst the retailer should deliver on this, it is hard to justify the premium the market is currently willing to pay for its shares over Wal-Mart and the rest of the market.

Costco has traditionally traded at a significant premium to Wal-Mart and deservedly so. In the last decade it has delivered stunning growth and has been one of the best performers on the S&P 500. But at this point in time it is very hard to justify paying 29x earnings for a company that is growing earnings at the smallest fraction of a percent.

A multiple of 29x earnings is not only expensive in comparison to Wal-Mart and the rest of the market, but it is also a premium to where Costco's shares have traded at in the last decade when earnings growth was stronger.

It is expected that the Fed will raise rates in December and then upwards of three times (all being well) in FY 2017. If this does eventuate then the US dollar index has the potential to break through the $100 mark once again. Therefore, deflationary pressures and currency headwinds will continue to plague the company and hindering its growth for the foreseeable future.

Although the market has been very patient recently, it is felt that another year of slow growth may cause many investors to head for the exits and drive the share price down to a more respectable level.

Ultimately management's guidance for the year ahead at the next earnings call will make or break the stock. If management appears overly bullish on FY 2017 and is able to expand margins to stimulate earnings growth then things may well be okay. But if it is reliant purely on a lift in sales to drive earnings growth then they may have a problem on their hands.

At the current price in this current economic environment, this discount retailer is simply too expensive.

As a warehouse club, the Costco model is built on offering great prices but limited selection. In the past, that made other warehouse clubs such as Wal-Mart's (NYSE:WMT) Sam's Club its only real competition. Now, however, the chain increasingly has to deal with traditional stores offering aggressive pricing.

Wal-Mart specifically has committed to spending billions to lower prices. That's a big problem for Costco, because the traditional retailer's deals don't require buying food in specific large quantities.

If a regular grocery store will sell a box of cereal at a price close to what Costco charges, but the warehouse club requires buying two extra-large boxes, it's easy to see why consumers may shy away from bulk purchases. That's not a big problem if it simply costs Costco some sales, but it becomes a much bigger issue if consumers stop believing Costco consistently has the best deal.

If that happens, people will drop their memberships -- and fees from people paying their annual dues accounts for 75% of the chain's profits.

Costco has mostly ignored the Internet because it's built its business around driving people to its stores. That makes sense because once people hit a warehouse; they can be enticed into buying things they'd not planned on. In addition, part of the Costco mystique revolves around bargain hunting in its stores.

That's generally been a strong formula. People join Costco partly because it's fun to shop in the stores even when you don't buy anything. Add that to the fact that prices are generally below other options (albeit with the hassle of having to buy in bulk), and you can see why the chain has thrived.

Amazon.com (NASDAQ:AMZN) has already taken away one of those advantages. It has comparable, and in some cases lower, prices than the warehouse club chain. It also has improved delivery to the point that it can get pretty much anything to consumers in two days or less.

Costco Wholesale Corp.’s 50 day moving average is $160.14 and its 200 day moving average is $156.44. The company has a market cap of $66.23 billion, a PE ratio of 28.57 and a beta of 0.59. Costco Wholesale Corp. has a 12 month low of $138.57 and a 12 month high of $169.73.

Tuesday, 27th September, 2016
Paychex, Inc. (NASDAQ:PAYX) Calls

**OPTION TRADE: Buy the PAYX OCT 21 2016 60.000 call at approximately $1.10. Sell price is left to your own judgment.

Paychex, Inc. (NASDAQ: PAYX), is set to report first-quarter fiscal 2017 results on Sep 28. Last quarter, the payroll and human resource solutions provider’s earnings were in line with the Consensus Estimate.

Paychex’s investments in product development and focus on boosting sales force to drive revenues are positive. It is believed that the company’s expansion initiatives, including joint ventures and acquisitions, are in sync with its long-term growth strategy.

One of the key secular growth drivers for Paychex is demand for outsourcing. Human Resource Services outsourcing is a large, less-than-half-penetrated market that offers significant cost-cutting potential. Moreover, growing regulatory burden on small companies underscores the increasing need for outsourcing non-core activities.

The company continues to capitalize on this opportunity by regularly introducing new products and services for up-selling and moving into the mid-market, which should boost results in the to-be-reported quarter.

Going further, there is plenty of optimism that Paychex might witness growth by successfully cross-selling newer products such as Paychex Premier, Major Market Services (MMS) and ancillary HRS products such as 401(k) record keeping, health insurance sales and workers' compensation administration to the existing client base. This strategy is likely to positively impact the company’s fiscal first-quarter results.

This $21 billion payroll services stock is up more than 10% since the calendar flipped to January, rallying thanks to a combination of improving jobs numbers and ongoing interest rate hike drama. At the same time, short sellers have entrenched themselves in this stock pushing its short interest ratio up to 14. That signals nearly three weeks of buying pressure would be needed for shorts to exit their trades out at today's volume levels.

Morgan Stanley reaffirmed an “underweight” rating and issued a $49.00 target price on shares of Paychex in a research report on Tuesday, August 23rd.

Zacks Investment Research raised shares of Paychex from a “hold” rating to a “buy” rating and set a $61.00 target price for the company in a research report on Thursday, June 2nd.

Paychex Inc. has a one year low of $45.55 and a one year high of $61.87. The company’s 50-day moving average is $59.95 and its 200 day moving average is $56.30. The firm has a market capitalization of $21.60 billion, a P/E ratio of 28.67 and a beta of 0.82.

Tuesday, 27th September, 2016
ConAgra Foods Inc (NYSE:CAG) Puts

**OPTION TRADE: Buy the CAG OCT 21 2016 43.000 put at approximately $1.10. Sell price is left to your own judgment.

ConAgra Foods, Inc. (NYSE: CAG), an operator of a packaged food company, will report its fiscal first-quarter results on September 29 ahead of the opening bell. The consensus calls for earnings of $0.48 per share, up from $0.45 during the same period last year.

Conagra has been trending steadily lower over the last two months, and shareholders need to see a strong quarter for the stock to regain its footing and trend higher. The strong dollar is had a material impact on the company’s international revenue and margins. Last quarter, the company reported earnings that were in-line with the consensus, while revenue fell slightly short of estimates.

The stock is up a modest 3.5% on the year.

Why ConAgra Foods?

ConAgra Foods Inc. has been in dangerous territory. After a couple of short-lived pullbacks to start 2016, their stock has been trading above its 200 day moving average since the middle of February. In its most recent earnings release, ConAgra Foods reported lower than expected sales numbers. This sent their stock trading lower and has been on a downward slide all summer. Currently the stock's forward price to earnings ratio is at 18.42, which is slightly ahead of the S&P 500.

ConAgra Foods' stock price target was lowered to $46 from $48 at Deutsche Bank last Friday.

The firm maintained a "hold" rating on shares of the packaged food company.

"ConAgra is moving ahead with a more focused, logical strategy but we have doubts around long-term strength of the company's brands," Deutsche Bank wrote in an analyst note.

"Many questions remain as to future capital structure and we look forward to further details around the Lamb Weston spin at the October Analyst Days. We believe current valuation appropriately reflects short and long-term challenges vs. opportunity," the firm added.

Last year, ConAgra announced plans to separate into two, independent public companies. Lamb Weston will be a food service supplier of frozen potatoes.

Separately, TheStreet Ratings Team has a "Hold" rating with a score of C+ on the stock.

The primary factors that have impacted the rating are mixed. The company's strongest point has been its expanding profit margins.

But the team also finds weaknesses including deteriorating net income, generally higher debt management risk and weak operating cash flow.

ConAgra Foods has a 12 month low of $37.97 and a 12 month high of $48.81. The firm’s market cap is $19.11 billion. The stock’s 50 day moving average is $45.45 and its 200 day moving average is $45.74.