Costco Shares Underperform Post-Q2 Earnings

Costco Navigates Post-Earnings Scrutiny Amid Margin Concerns

Costco Wholesale Corporation ($COST) delivered mixed results for its second fiscal quarter of 2024, reporting diluted earnings per share of $3.78 on revenue of $58.44 billion, falling short of analyst expectations for EPS but slightly exceeding revenue forecasts. The warehouse retailer, known for its bulk sales and membership model, revealed a 5.6% increase in net sales for the 12-week period ended February 18, 2024, compared to $55.27 billion in the prior year. Despite the revenue beat, comparable sales growth, excluding gasoline and foreign exchange impacts, decelerated to 5.8% globally, with U.S. comparable sales up 4.8%.

The immediate market reaction was decisively negative, with $COST shares plummeting 7.6% on March 8, 2024, to close at $724.08. This sharp decline was accompanied by a surge in trading volume, significantly exceeding its 30-day average, indicating a broad-based investor re-evaluation rather than isolated profit-taking. The sell-off reflected concerns over moderating comparable sales, particularly in discretionary categories, and the ongoing pressure on gross margins, despite the resilience of its core membership model.

Market Impact

The 7.6% drop on March 8 wiped out approximately $28 billion from Costco's market capitalization, reducing it to around $320 billion. This marked the stock's largest single-day percentage decline since October 2022, when it fell 7.7% following a previous earnings report. The share price has since struggled to recover, contributing to an 8.9% loss over the past six months, underperforming the S&P 500's ($SPX) 15.3% gain over the same period.

Before the Q2 report, $COST had reached an all-time high of $795.71 in late February, driven by optimism surrounding its consistent membership growth and potential for a membership fee increase. However, the post-earnings pullback has pushed the stock below key technical support levels, including its 50-day moving average, which currently stands near $745. The broader retail sector, as tracked by the SPDR S&P Retail ETF ($XRT), saw a more modest 0.9% decline on March 8, suggesting that Costco's specific operational details, rather than a general retail slowdown, were the primary drivers of its underperformance.

What Analysts Are Saying

Analysts have offered a mixed perspective following Costco's Q2 report, with some maintaining a bullish long-term outlook while others express caution regarding its valuation. According to JPMorgan analysts, "Costco's underlying membership trends remain robust, with renewal rates in the U.S. and Canada holding steady at 92.7%, indicating strong customer loyalty." They emphasize that the 8.2% year-over-year increase in membership fee revenue to $1.11 billion underscores the stability of this critical profit stream, potentially paving the way for a fee hike in the next 12-18 months. JPMorgan reiterated an 'Overweight' rating, citing the company's defensive characteristics in an uncertain economic environment.

Conversely, Wells Fargo analysts highlighted concerns over gross margin compression and slowing discretionary sales. "While Costco's top-line revenue beat expectations, the deceleration in comparable sales, particularly in non-food categories, suggests increasing pressure on consumer discretionary spending," they noted. Wells Fargo maintained a 'Market Perform' rating, pointing to Costco's elevated valuation—trading at approximately 35 times forward earnings—as a potential impediment to further upside given the current growth trajectory. They suggest that the premium valuation leaves little room for error, particularly if inflationary pressures persist and impact consumer purchasing power more broadly.

What to Watch

Investors should monitor several key factors that could influence $COST's performance in the coming quarters. The timing and magnitude of a potential membership fee increase remain a significant catalyst; the last increase occurred in June 2017, and an announcement could provide a substantial boost to profitability. Analysts will be scrutinizing the Q3 fiscal year 2024 earnings report, expected in late May, for signs of improvement in comparable sales trends, particularly in non-food categories, and any stabilization in gross margins.

From a technical perspective, the stock's ability to reclaim and hold above the $730 level will be crucial, as this area has acted as both support and resistance in recent months. Key support levels to watch are $710, representing the low from early February, and $695, a more significant long-term support. Conversely, resistance is likely to be found at its 50-day moving average, currently near $745, and then at the $760 level. Persistent inflation and a sustained slowdown in consumer discretionary spending pose significant risk factors that could further weigh on Costco's performance, potentially reversing any upward momentum.