The rally of Costco Wholesale Corp. (COST) stock into the weekend might not kick off the trend many hope.
The wholesale leader stock is the biggest gainer in the S&P 500 on Friday, marking an over 5% gain in afternoon hours. Yet, the devil is in the details according to some unconvinced analysts.
Pricey Among Peers
One aspect of Costco that is difficult to sustain is its multiple that stands markedly above its competitors.
"Big beat in the second quarter as the business continues to perform at a high level. However, this is reflected in COST's premium multiple and the magnitude of the beat, which was inflated by unusually high gas profitability," Morgan Stanley analyst Simeon Gutman said. "Seems unsustainable."
He advised clients stay neutral as the risk-reward appears to have found equilibrium in his view, setting a $220 price target.
For reference, the forward price-to-earnings ratio for Costco has powered past peers amid the surge. The ratio now sits at 28, above Walmart Inc. (WMT) , which stands at about 20, and nearly twice that of Massachusetts-based rival BJ's Wholesale Club Holdings Inc., (BJ) .
In the context of its peer group, the stock certainly isn't cheap, as Gutman notes.
Gaining on Gas
Aside from valuation, the strong earnings garnered in the quarter might be a bit abnormal due to surprisingly high gas profits. The contribution was outright acknowledged by Costco CFO Richard Galanti in the earnings call.
"We think we're fortunate in the fact that we turn a lot of gas. We literally turn inventory about daily. And as you know, we have locations with up to 24 pumps in there backed up all the time," Galanti commented. "I think everybody seems to have been taken a little more, and that's giving us the ability to do so over the last couple years. But I guarantee you, it will be volatile, and we'll always tell you that it was certainly a little more of a benefit this quarter than normal."
Quantifying the benefit was a bit more difficult, but Gutman estimated that about half of the big beat in earnings per share is attributable to higher profitability in gas sales.
"We assume the remainder of the beat (~16 cents) was largely attributable to higher than usual gas profitability, consistent with COST's commentary," Gutman wrote on Friday. "As gas prices are volatile and have already begun to rise during Q3 to date, we do not expect to see similarly sized benefits going forward."
J.P. Morgan estimates went as far as to place 17 cents of the earnings beat on gas profitability, reining in the core of the still impressive results.
So, while the results are unquestionably good, especially with the expansion of margins, investors need to be cognizant of the fuel that is driving earnings.