Costco Wholesale Corporation (NASDAQ: COST) experienced a downgrade from Redburn Atlantic on Tuesday, driven primarily by concerns over the stock’s high valuation.
Analyst Daniela Nedialkova, who previously rated Costco as Buy, lowered her rating to Neutral while simultaneously increasing the price target to $890 from $860.
This suggests that while Costco remains a high-quality company with a solid business model, its current valuation might limit its potential upside.
Specifically, Costco’s 2025 price-to-earnings (P/E) ratio stands at an elevated 50x, leading to concerns that the risk-reward profile is becoming less favorable, particularly with many of the growth catalysts already priced in.
What does Costco’s August sales data say?
Recent sales data underscores Costco’s robust performance, with the company reporting a 7.1% increase in total sales for August 2024, bolstered by a 5% rise in comparable sales.
After adjusting for gas and foreign exchange fluctuations, comparable sales were still up 7.1%.
Non-food items, particularly jewelry, gift cards, and sporting goods, saw low double-digit growth for the third consecutive month.
E-commerce also continues to be a bright spot, with a 16.2% year-over-year increase in comparable sales for the 52 weeks ending September 1, 2024.
Analysts from Jefferies and Oppenheimer have both noted Costco’s strong merchandising efforts and value proposition, contributing to its solid sales momentum.
The company’s growth in membership has been a key driver of its financial performance, with memberships rising by 9.4% year-over-year to 74.5 million in Q3 2024.
Despite the challenging economic environment, Costco’s financial resilience is evident in its ability to maintain and even expand margins, albeit slightly, during the last quarter.
However, the company’s gross margins retracted marginally from 11.04% in Q1 to 10.84% in Q3, reflecting some pressure from a slowing economy and financially constrained consumers.
Nevertheless, the company’s brand strength and customer loyalty continue to support its financial performance, even in a high-interest rate environment.
Costco Q4 earnings preview
Looking ahead to Costco’s Q4 2024 earnings, analysts seem to be optimistic.
The consensus estimate is for Costco to report earnings per share (EPS) of $5.06 on revenues of $79.98 billion, up from $4.87 EPS on $78.94 billion in the same quarter last year.
Thirteen out of the fourteen analysts covering the stock have revised their guidance upwards in the past 90 days, reflecting expectations of continued strong performance.
In terms of valuation, Costco’s current P/E ratio is significantly higher than its historical average and those of its peers.
At 56x forward earnings, the stock appears to be priced for perfection, leaving little room for error.
This elevated valuation could be vulnerable to a correction, especially if broader market conditions deteriorate or if Costco’s future earnings growth fails to meet investor expectations.
Additionally, the potential impact of weight loss medications, which are reducing food demand across the retail sector, could further complicate Costco’s growth trajectory, particularly given its reliance on bulk food sales.
Despite these headwinds, Costco continues to exhibit several tailwinds, including strong customer loyalty, a unique treasure hunt shopping experience, and robust membership growth.
However, with its valuation stretched and risks mounting, particularly in the context of rising interest rates and a potentially slowing economy, the stock’s near-term upside may be limited.
Analysts have also pointed out the possibility of a stock split as a potential catalyst, although the impact of such a move on the stock’s valuation and performance remains uncertain.
With the fundamentals laid out and valuation concerns in mind, the next step is to analyze how these factors are being reflected in the stock’s price movement.
Let’s delve into the technical indicators to see if the charts support or contradict the cautious outlook on Costco by Redburn Atlantic.
Costco stock technical analysis
Costco’s stock has generated over sixfold returns in the last 10 years. Moreover, the stock has seen a very strong uptrend, rising over 60% over the past year.
Taking those factors into account, one doesn’t even need to look at the charts to conclude that the stock is bullish across timeframes.
Source: TradingView
However, investors who haven’t bought the stock yet need not rush and buy it at current levels as it seems to be facing some resistance trading above $900 over the past few days.
Additionally, after such a strong move over the past year, one should ideally look for a retracement to enter the stock.
If the stock fails to rally above $900 soon, it can spend some time in the $790-$800 over the coming months and investors must look to enter the stock at the lower end of that range.
For traders who have a bearish outlook on the stock, it wouldn’t be a wise move to initiate a short position at current levels despite the resistance it is facing above $900. A short position must only be considered if the stock falls below its 50-day moving average or its recent swing low at $793.
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