Bullish Case For Costco, Sprouts Comes To An End At Barclays

The bullish case for food and staples retailers Costco Wholesale Corporation COST and Sprouts Farmers Market Inc SFM have come to an end at Barclays for valuation reasons.

The Analyst

Analyst Karen Short downgraded Costco from Overweight to Equal Weight with an unchanged $240 price target. The analyst also downgraded Sprouts Farmers Market from Overweight to Equal Weight with a price target lifted from $26 to $30.

The Thesis

The management teams at both Costco and Sprouts remain "laser-focused on exceptional execution" and their status as best-in-class food and staples retailers remains unchanged, Short said in the downgrade note. (See her track record here.) 

A neutral stance is warranted, as both stocks have hit Barclays' price targets, the analyst said. 

Costco: Highest Multiple In 12 Years

Costco's stock is trading at a 16 times forward EV/EBITDA multiple, the highest level seen in 12 years, if not an all-time high, Short said.

The high valuation may be justified given 15-year average EBITDA growth of 8.8 percent on 7.9-percent revenue growth, she said. Yet a moderation of EBITDA growth to 6.7 percent in fiscal 2019 and 7.2 percent in fiscal 2020 is now expected, and even if growth comes in higher than expected in the coming years, it won't "remedy valuation concerns," the analyst said. 

Barclays' $240 price target is based on a 15 times EV/EBITDA multiple on fiscal 2020 EBITDA estimates of $6.8 billion.

Sprouts: Minimal Valuation Upside

Sprouts' stock has traded at about an 11.5 times NTM EV/EBITDA multiple over the past two years and there is minimal reason to justify a higher valuation, Short said in the downgrade note.

The increase in ROIC in the first quarter is mostly due to a lower tax rate and tax reform, which implies any tax-related benefit is already reflected in the stock's current multiple, according to Barclays. 

The grocery and food retail sector is at its core a zero-sum game, as consumers may shop at more expensive stores, but they aren't eating more, Short said. Expectations for upside to same-store sales in fiscal 2019 and 2020 are limited, which implies minimal upside to earnings, she said. 

The company also faces continued pressure from competition and a decline in EBITDA margins from 8.9 percent in fiscal 2014 to 6.6 percent in 2018, a trend the analyst said is unlikely to ease.

The revised $30 price target is based on an 11.3 times EV/EBITDA multiple on fiscal 2019 EBITDA estimates of $379 million.

Price Action

Shares of Costco were trading lower by nearly 1 percent Monday morning while Sprouts Farmers Market's stock was down by 0.5 percent.

Related Links:

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