Chart Says This Retailer Is Set For A Breakout

Melvin Pasternak's picture

Monday, April 28, 2014 - 11:15am

by Melvin Pasternak

Peter Lynch talks about paying attention to the "power of common knowledge." His advice is to notice which stores and products are most popular when you visit the mall. Then you do your research, and if the story checks out, buy the shares. 

A recent visit to my local Costco Wholesale (Nasdaq: COST) on a weekday afternoon was instructive. The parking lot was jam-packed and it took about 15 minutes to find a spot. Once inside, the aisles were also packed with shoppers. Oh, and despite the many discounts (or maybe because of them), I left with a bill well into the triple digits.

My experience is not unique. With scores of customers pouring into Costco's stores, it's no wonder the company is doing well.

Three factors seem to be driving Costco's success: new store growth, new member sign-ups and strong existing membership renewals.

Currently, there are 650 Costco stores worldwide, with the majority (462) in the U.S. Two years ago, management announced plans to open at least 15 new stores per year. This target has now doubled to 30.

Membership plays an important role in Costco's business model. Member fees enable the company to sell products at wholesale prices. They also provide stability to Costco's cash flow since fees are at a fixed price and collected in advance, unlike food and commodity prices, which fluctuate throughout the year.

You can't shop at Costco unless you purchase a membership. The cheapest option is $55 a year. But when I did some field research at the Costco nearest me, every customer service employee I spoke to advocated the $110 annual membership, which would earn me 2% cash-back rewards.

In the most recently reported quarter, new member sign-ups increased 13%. Much of this growth came from international expansion, primarily from new store openings in Japan and Australia.

Solid membership renewals also contributed to Costco's 5% increase in same-store sales in March, which was well above the 3.5% expected by analysts. The renewal rate for existing members was 86.5%, showing customer loyalty. In the U.S., comparable-store sales rose 6%, while internationally, comp sales rose 4%, driven mainly by increased sales in Japan.

From a technical perspective, COST appears strong.

Rising off a May 2012 low near $75, shares formed a major uptrend, characterized by ascending peaks. The stock rose steadily until August 2013, when shares peaked near $120, then dipped to just above $109. Between July and October, COST consolidated between resistance just below $120 and support just above $109.

In late November, the stock briefly broke past resistance, moving to an all-time high of $126.12. However, shares could not sustain the breakout and slid, once more finding support near $109. In the process of the pullback, COST bearishly broke the major uptrend line.

For all of 2014 to date, the stock has consolidated between $120 resistance and $109 support in what seems to be an extended rectangle formation.

However, a significant technical development took place during the April 21 trading week when shares bullishly broke an intermediate downtrend line that lasted roughly five months. With that important downtrend broken, I now anticipate a strong rally with, at minimum, a test of the all-time high likely, although the shares could stall briefly at $120. 

The upbeat technical outlook is supported by solid fundamentals.

For the upcoming fiscal third quarter, to be reported May 29, analysts project revenue will increase 6.5% year over year to $25.6 billion. For the full 2014 year, analysts expect revenue will jump 6.3%, to $111.7 billion.

The earnings outlook is also strong. Analysts expect third-quarter earnings per share (EPS) will increase 4.8%, to $1.09, from the same period a year ago. For the full 2014 year, analysts project EPS will rise 3.1%, to $4.63.

Given the stock's technical and fundamental strength, I plan to go long on the big-box retailer.

Risks to Consider: Competition in the U.S. and international grocery market is nothing but intense. In addition to established chains like Safeway (NYSE: SWY), large discount and drugstores all fiercely target the consumer's food and beverage dollar. New entrants from unexpected sources could upset the competitive balance and undermine analysts' revenue and earnings projections.

Action to Take -->
-- Buy COST at the market price
-- Set stop-loss at $108.79, just below current support
-- Set initial price target at $125.78 for a potential 9% gain by late summer 2014

This article was originally published at ProfitableTrading.com: 
Major Technical Development Says Big-Box Retailer is About to Rally

P.S. Costco is a great buy-and-hold stock, but its 1.1% dividend yield won't satisfy many investors. Fortunately, my colleague Michael Vodicka has developed a strategy that multiplies the income regular investors can receive from the world's most reliable dividend payers. To learn more about this simple three-step process, follow this link.

Melvin Pasternak does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.