Why Costco, Kohl's, and Five Below Were All Sliding Today | The Motley Fool

Why Costco, Kohl’s, and Five Below Were All Sliding Today | The Motley Fool

What happened

Retail stocks including Costco (COST -12.45%)Kohl’s (KSS -11.02%), and Five Below (FIVE -11.54%) were getting shocked today after retail giants including Walmart and Target badly missed bottom-line estimates and their first-quarter earnings reports. Both companies also cut their guidance for the year, warning that challenges from inflation and supply chain disruptions would persist.

Though there was no company-specific news out on Costco, Kohl’s, and Five Below, all three companies will report earnings in the next two weeks, and investors seem to be fearful that they’ll experience similar headwinds.

As of 11:05 a.m. ET, Costco stock was down 11.4%, while Kohl’s had given up 10%, and Five Below was off 9.1%. Meanwhile, Target lost 24.4% after its earnings dud this morning, and Walmart was down 17% over the last two days since reporting earnings yesterday.

Image source: Getty Images.

So what

What seems to be happening in the retail sector is that stocks are being “re-rated” based on economic headwinds such as inflation and supply chain issues. That means that valuations, which arguably had gotten inflated during the pandemic, are falling across the board. 

Retailers are also running into difficult comparisons as tailwinds from stimulus spending and pandemic hoarding a year ago have dissipated, and consumer spending is shifting back to services like travel and restaurants rather than goods, as Target management said today.

Costco may be the best example of what the market sees as an overpriced retail stock. Though the warehouse chain has been a top performer, Costco’s price-to-earnings ratio has climbed to 35, nearly double that of the S&P 500, even as the company operates in a slow-growth sector. That valuation makes Costco one of the most expensive brick-and-mortar retail stocks. While it deserves to trade at a premium to its peers, it’s reasonable to question whether its valuation has become too inflated.

The company continues to post strong top-line results, with comparable sales up 8.7% in April, but the bottom line could feel a pinch when the retailer reports earnings after hours on May 26. Analysts expect earnings per share to rise from $2.75 to $3.05, according to the report.

Kohl’s is a lot cheaper than Costco, but it’s also a much weaker business. The company has been searching for strategic direction in recent years, teaming up with Amazon to accept returns and subleasing excess space to retailers like Aldi. While the company has been solidly profitable, department store chains tend to do poorly during recessions as they sell primarily discretionary items, and Kohl’s doesn’t control its own inventory the way Costco does with its Kirkland brand.

Kohl’s is set to report first-quarter earnings tomorrow morning, and analysts predict earnings per share to shrink from $1.05 to $0.70.

Finally, Five Below, the mall-based chain specializing in items like games and toys for $5 or less, should benefit from the economic reopening as its business model is based on store traffic and the “treasure hunt” experience of looking through its merchandise. However, with a highly discretionary model and its product range, the company is likely to feel the impact of cost inflation and supply chain constraints, especially as it’s limited in its ability to raise prices. 

Five Below is expected to report first-quarter earnings in the first week of June, and analysts see earnings per share sliding from $0.88 to $0.59. 

Now what

The good news for retail investors is that the current inflationary conditions and economic headwinds are temporary. While the next few quarters could be challenging, the economy should eventually return to a more secure footing.

We’ll learn more about these stocks once they report their upcoming quarterly earnings, but an ongoing sell-off in the sector could be a good opportunity to buy shares of quality companies like Costco.

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