Costco Should Report Steady Growth For Q3

Warehouse retailer Costco (NASDAQ:COST) is scheduled to release its Q3 fiscal 2013 earnings on May 30. According to the company’s press release, it registered steady growth during February, March and April. ^[1] Comparable store sales (CSS) during these months increased by roughly 4-6%. ^{[2] [3]} Interestingly, the prolonged cold in the U.S. which troubled a number of retailers including Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) did not have much impact on Costco due to a lower proportion of weather sensitive products in its merchandise. In this article, we’ll look at some of the factors that helped Costco’s results in this quarter.

Costco’s attractive bargains and growing customer base along with its focus on executive members and private label brands helped drive comparable store sales growth. The retailer is leveraging the growing online retail market by strengthening its e-commerce channel, which seems to be paying off. However, foreign currency fluctuations and lower gasoline prices negatively impacted Costco. Excluding their impact, the comparable store sales growth for all the three months of the quarter stood at 6% (Read: How Important Are Gasoline Prices To Costco?).

See our complete analysis for Costco

Attractive Bargains Resulting In Membership Growth

Why Is Coscto’s Membership Base Growing?

As a warehouse club, Costco provides merchandise at lower prices compared to its competitors. The retailer does so by keeping product markups low at around 15% while the same figure for most supermarkets and department stores is over 25%. ^{[4] [5]} Moreover, with concrete floors, simple shelves and display boxes, Costco keeps costs to a minimum. The retailer possesses strong negotiating power over its vendors as it buys large quantities of fewer SKUs. It regularly changes the brands it offers by buying the brands that have larger inventories to get more discounts. ^[6] Hence, the customers always find something new at Costco. These strategies allow the retailer to offer merchandise at compelling prices, attracting buyers to become Costco members.

What Has Been The Impact?

Over the last few years, Costco has seen a noticeable increase in the number of new members. While the retailer added 2.3 million members in 2009, more than 4 million customers signed up in 2011. ^[7] The company stated that over 1.6 million new members joined Costco during the first two quarters of fiscal 2013. ^{[8] [9]} Moreover, the membership renewal rates have improved as customers are returning to Costco, troubled by rising gasoline prices and the payroll tax increase. While the membership renewal rate for North America remained flat at 89.7% during Q1 fiscal 2013, it improved slightly to 89.8% in the second quarter. ^[9] Similarly, the figure for international markets increased to 86.5% in Q2 after remaining stable at 86.4% for two consecutive quarters. The improving renewal rate despite a 10% rise in membership fee (November 2011), is an encouraging sign for Costco and this is likely to continue this quarter as well.

Increasing Penetration Of Executive Members And Private Label Brands

Executive members pay $110 as membership fee (as opposed to $55 paid by the other members) to get 2% (maximum of $750) annual rewards on their purchases. ^[7] They represent one-third of Costco’s overall customers and two-third of its revenues. The proportion of these members in Costco’s overall membership base has been rising historically, increasing from 33% in fiscal 2009 to 38% in fiscal 2012. Even in Q2 fiscal 2013, while the total number of members increased by 1%, executive members grew by 1.4%. ^[9] To drive executive member signups, Costco recently increased the rewards cap from $500 to $750. We expect the proportion of executive members to further rise in this quarter, aiding the retailer’s revenue growth.

The key selling point of Costco is its private label brands such as Kirkland Signature. According to the company, these brands are comparable in quality to national brands and are often cheaper. ^[7] The retailer has been increasing the share of these brands within its overall product range by 0.5%-0.75% annually. ^[8] Private label brands accounted for about 20% of Costco’s merchandise at the end of Q2 fiscal 2013, and the retailer plans to increase this figure to 30%+ range. ^[9]

Increasing Online Retail Sales

The online retail market in the U.S. has grown rapidly since 2004 and the long-term outlook remains optimistic. Forrester forecasts that online sales in the U.S. will grow 13% to $262 billion in 2013 and reach $370 billion by 2017. ^[10] As we don’t see any reason for online retail growth to halt this quarter, the industry trend is likely to drive Costco’s online sales. This will be further complemented by the retailer’s e-commerce strategy. Costco offers distinct products in its stores and e-commerce site to keep its customers interested. ^[9] Last quarter, the company stated that about 80%-90% of its products offered online do not overlap with the store inventory. ^[9] This allows the retailer to operate two distinct channels without having to worry about self-cannibalization.

Our price estimate for Costco stands at $113, which is inline with the market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Costco Wholesale Corporation Reports February, Second Quarter And Year-To-Date Results, Costco, Mar 7 2013 [↩]
2. Costco Wholesale Corporation Reports March Sales Results, Costco, Apr 11 2013 [↩]
3. Costco Wholesale Corporation Reports April Sales Results, Costco, May 9 2013 [↩]
4. Costco’s Unorthodox Strategy To survive The Big Box Apocalypse, Business Insider, Mar 7 2013 [↩]
5. How Costco Became The Anti-Wal-Mart, The New York Times, July 17 2005 [↩]
6. Inside Costco: Secret’s Of America’s Favorite Stores, abc news, March 29 2010 [↩]
7. Costco’s SEC filings [↩] [↩] [↩]
8. Costco’s Q1 fiscal 2013 earnings transcript, Dec 12 2012 [↩] [↩]
9. Costco’s Q2 fiscal 2013 earnings transcript, Mar 12 2013 [↩] [↩] [↩] [↩] [↩] [↩]
10. U.S. Online Retail Sales To Reach $370B by 2017, Forbes, Mar 14 2013 [↩]