Pair Trade? UBS Upgrades Costco, Downgrades American Express

• Costco Wholesale Corporation COST shares are up 9 percent year-to-date, while shares of American Express Company AXP are down 21 percent over the same period.
• UBS analyst Michael Lasser upgraded Costco from Neutral to Buy, while analyst Matthew Howlett downgraded the rating on American Express from Neutral to Sell.
• While Costco is poised to benefit from the switch from AMEX to Visa, American Express will be hit severely, the analysts said.

Costco To Benefit From Switch From Amex to Visa

Analyst Michael Lasser raised the price target for Costco from $153 to $180. He mentioned that the company’s move from Amex to Visa is generating significant benefits that are being under-appreciated. The move will not only lead to additional members and sales, but also increased earnings.

Lasser expects Costco’s share price to be supported as the markets look forward to the company raising its membership fees in late 2016 or early 2017. “We estimate that COST will increase its membership fee by $10 in late 2016. This will add ~200 bps to its EPS growth in FY'17.”

The rapid growth of Costco’s ancillary business and stable fuel prices are expected to boost the company’s gross margins. The UBS report added that currency is expected to have a limited negative impact on the company’s top-line in future quarters.

“We recognize that COST sports a big multiple (25x ’17 cons EPS), but we think the premium is more than justified given the durability and portability of the business, along with the potential for another upward inflection in the co's trends,” Lasser wrote.

Costco Loss To Be Severe For American Express

Analyst Matthew Howlett reduced the price target for American Express from $81 to $67. The results of a UBS Evidence Lab Survey of US Costco members and AXP-Costco co-brand cardholders indicate a large detrimental impact of the end of American Express’ partnership with Costco.

“We now expect AXP to lose 8.1% of its card members (vs. our 2.5% previous estimate), 8.0% of its network volume (vs. 4.5%), and 18% of its loan portfolio (vs. 12%) after March 2016,” Howlett said.

American Express may not be able to achieve its long-term earnings growth target in the next several years. “We simply do not see a clear path to strong earnings growth even after the Costco dust has settled,” Howlett added.

The steady deterioration in American Express’ earnings power, restrained consumer spending and membership growth and anemic consumer appetite for loan growth remain concern areas, the UBS report stated. “We believe AXP will see difficulties in meeting its expense growth target, particularly given what we expect to be significant pressure to spend on marketing and rewards.”

American Express needs to undergo a significant transformation to “adapt to the evolving nature of the payment industry and its own closed-loop model,” Howlett said.