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 (NASDAQ: COST) and selling Wal-Mart Stores, Inc. (NYSE: 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.