An Interesting Retail Pair Trade: Costco Outperform, Wal-Mart Underperform

A relatively weak Q1 earnings season once again has traders worried about a market downfall, yet so far, the S&P 500 has been fairly resilient. In uncertain times like these, pair trades offer the potential for upside with protection to the downside in the event of a market selloff.

RBC Capital analyst Scot Ciccarelli may have identified the perfect pair trade in the retail sector. According to Ciccarelli, traders should be buying Costco Wholesale Corporation COST and selling Wal-Mart Stores, Inc. WMT.

Ciccarelli believes that Costco’s unique low-margin business model helps protect it from e-commerce competition, a characteristic that deserves a premium valuation in the market.

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“Costco’s membership model provides it with a growing, high-margin revenue stream, while the extreme values it provides to members and treasure-hunt design has led to some of the best/most consistent customer traffic growth in all of Retail,” Ciccarelli explained.

When it comes to Wal-Mart, however, he sees little room for growth and an ever-growing field of competition. Despite the stock’s 14 percent selloff in the past year, RBC still believes that the risk/reward balance is skewed to the downside.

RBC has initiated Wal-Mart at Underperform with a price target of $66 and initiated Costco at Outperform with a price target of $169.

Disclosure: The author holds no position in the stocks mentioned.