Analysis: COST TGT WMT UPS

After you receive this alert, we will buy 35 shares of Costco Wholesale (COST)  at or near $431. Following the trade, the portfolio will own 245 COST shares, roughly 3.0% of the portfolio.

Equities are giving back yesterday's gains following the disappointing results out of Target (TGT) , which in our view offers some context for Walmart (WMT) , but also reaffirms our view that the next two weeks will be full of challenging earnings reports from retailers, particularly full-price ones.

Similar to Walmart, Target reported positive quarterly comps, but it also shared that "overall costs have been rising much faster than retail prices, resulting in year-over-year declines in our gross margin rates" adding that it doesn't "see current condition improving right away." In particular Target called out freight costs, noting during its earnings conference call that "first quarter freight and transportation costs came in hundreds of millions of dollars higher than our already elevated expectations. And for the full year, we're now expecting about $1 billion of incremental freight costs, even compared to our expectations only 3 months ago."

Freight costs will be a thorn in the side of those companies, especially retailers, that need to move physical products from distribution center to store locations. And odds are they are paying fuel surcharges, which should be aiding the business at UPS (UPS) .

Getting back to Target, it didn't provide bottom line guidance for 2022, which means we'll revisit those EPS expectations in the coming days. We'll be matching them up against the rather aggressive second half EPS expectations shared by Walmart yesterday.

Now let's turn to Costco, as its shares are once again getting slammed today as investors head for the retail hills. Members know we favor the company given its differentiated business model vs. other retailers that offers a degree resiliency in its earnings.

We'd point out that during 2009, better known as the Great Recession, Costco's dipped only 1.5% vs. its 2008 while its EPS fell 11.7%. During 2009, the company continued to grow its warehouse footprint, adding 15 locations bringing the total at the tie to 527. As we know, the company exited 2021 with 815 and per its April 2022 comp sales report had 829 active warehouses. That expansion has led its high margin membership fee revenue to grow from $1.5 billion in 2009 to $3.9 billion during its fiscal 2021. As we've shared previously, the membership fee revenue stream accounts for roughly 70%-75% of Costco's net income.

High inflation also gives Costco the perfect excuse to announce a modest membership fee price hike, which would be very beneficial to its bottom line. Chatter points to such an increase coming mid-year given that it tends to increase the membership fee every five years. With its last such increase in 2017, the odds are likely we could see a new one in the coming months. Depending on the timing that would have a modest impact on 2022, but as the 115 million or so Costco cardholders renew their membership in the coming year, the company will see a nice boost to its all-important membership fee income.

We see some estimates purporting consumers are now paying the equivalent of $5,000 per year on gasoline vs. $3,800 in March and $2,800 about a year ago, we continue to see Costco's retail business winning consumer wallet share. We pointed this out once again with yesterday's April retail sales report analysis, and we expect it will continue to do so as consumers not only look to offset higher food costs but also those for gasoline.

If we were to look for a silver lining it would be the price compression in COST shares has pushed the position size in the portfolio to the point that we can comfortably add the shares. We're doing just that with this trade.

(Please note that we are looking to execute these trades at or near the share price mentioned above. Once the trade is completed, subscribers can see the trade's executed price here. Be sure to toggle the chart to sort by Purchase Date.)

Note: With Chris under the weather and Bob on the road, there will no AAP Daily Rundown today. We apologize for the inconvenience and will be back with the Rundown on Monday, May 23.

Action Alerts PLUS is long COST, WMT and UPS.