Costco Beats Estimates On Strong Online & Membership Growth
Warehouse giant Costco (NASDAQ:COST) recently reported Q4 and fiscal full-year 2014 results that came in ahead of the market consensus. (Fiscal years end with August.) The retailer’s revenues for the fourth quarter increased 9% to $35.52 billion, while analysts polled by Thomson Reuters expected the figure to be around $35.47. [1] With strong sales growth and improvement in gross margins, Costco’s earnings per share jumped 13% to $1.58, comprehensively beating the consensus estimate of $1.52. [2]
The retailer’s income growth looks even more pleasing considering that certain items negatively impacted its earnings. Unfavorable currency fluctuations lowered Costco’s Q4 fiscal 2014 EPS by $0.02 and income tax charges related to integration of Canadian operations with the U.S. business resulted in similar negative impact. Moreover, the company did not reduce its accrual for year end bonuses (as it did last year), that had a negative impact of $0.04 on its Q4 EPS. [3] In the absence of these items, Costco’s EPS would have been $1.66, which looks very impressive.
Apart from store expansion, the retailer’s strong revenue growth can be attributed to a healthy rise in new membership signups. Given the strength of its business model, Costco has been able to attract new memebrs, which should continue in the future given that it is expanding steadily in key new markets. Also, Costco’s e-commerce sales increased at a robust pace during the quarter, which not only had a marginal positive impact on its sales growth, but also on gross margins. The company is employing several strategies to ensure that its direct-to-commerce segment maintains a strong growth rate going forward, even as it builds a strong foundation for omni-channel retailing.
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Membership Growth Sustains a Strong Momentum
Over the last few years, Costco has seen a notable increase in the number of new members. While the retailer added 2.3 million members in fiscal 2009, more than 4 million customers signed up in fiscal 2011. The retailer’s membership base saw a rise of 3 million in fiscal 2012 and another 4.2 million joined Costco in fiscal 2013. Membership growth continued in all the four quarters of fiscal 2014. During the third quarter, new membership signups increased by 1% and renewal rate in the U.S. and Canada reached 90.6% from 90.4% in Q2. In international markets, it rose from 86.8% in Q2 to 87.3% at the end of Q3.
The fourth quarter of fiscal 2014 was particularly productive for Costco’s gross member additions. The retailer saw 2 million new membership signups during the quarter, which reflected an increase of 7% year over year. The surge in new signups was driven by strong response in international store openings in Australia, Korea and Spain. Overall, the company had a total of 76.4 million cardholders at the end of fiscal 2014, 1.8 million more than what it had at end of Q3. While overall renewal rates remained constant during the quarter, Goldstar renewal rates ticked up slightly from 89.6% (Q3) to 89.7%.
Given that membership renewal rates are already on the higher side, the company cannot expect much improvement going forward. However, with continued expansion and several efforts to attract customers, Costco can sustain sturdy growth in its new membership signups. During fiscal 2014, the company opened a total of 30 stores, including 17 in the U.S., three each in Canada and Australia, two each in Japan and Korea, and one each in the U.K., Mexico and Spain. In the current fiscal, Costco plans to open a total of 31 outlets, 13 of which will be in international markets. The retailer’s warehouse model has seen strong adoption in the U.S. and early signups in Australia and Japan have been very strong. With continued expansion in these regions, Costco should have no problems in adding new members.
Costco recently ran an eight day nationwide promotional program “Living Social” to entice buyers to become Costco members. It offered $20 Costco Cash card to new $55 membership signups along with three free items – a Kirkland Signature bath tissue, an apple pie and a rotisserie chicken. These free gifts can be construed as a goodwill gesture from the company, rather than an incentive for the buyers to join Costco. The retailer also started providing a free three month membership for identity theft protection, seeing how the recent data breaches have left customers with minimal confidence in credit payment systems. With the company enhancing its cyber security and encouraging buyers to sign up for it, we believe that customers will feel more secure about their transactions at Costco. This should have some positive impact on new membership signups going forward.
Online Growth Impresses
Costco generated a total of $3 billion in e-commerce revenues in fiscal 2014, which represents less than 3% of the company’s net sales. While the segment isn’t strong enough to have a material impact on Costco’s results, its strong and steady growth should not be ignored. Although the channel itself may not turn into a significant value contributor in the future, it will lay a strong foundation for Costco’s omni-channel platform. [3]
Comparable sales for the retailer’s fourth quarter e-commerce sales increased 19%, driven by key factors including: 1) an industry-wide customer shift towards online shopping; 2) Costco’s website re-platforming; 3) the introduction of new apps; 4) the addition of new categories such as apparel, health, beauty sundries, etc.; and, finally, 5) an improvement in delivery times. Over the past year, the retailer has been testing Google Shopping Express, a Google (NASDAQ:GOOG) initiative that provides consumers a platform to shop online from local retailers and get products delivered on the same day. Through this, Costco is mainly looking to expand its e-commerce reach, but it is still in test phase in three markets – the San Francisco Bay Area, Los Angeles and New York. In the years to come, the warehouse giant might look to roll this out on a larger scale, one that can have a noticeable impact on its e-commerce revenues.
Apart from contributing marginally to sales growth, Costco’s e-commerce business also helped its gross margins. The company’s chief financial officer, Richard Galanti, said during the earnings call that gross profit margins in e-commerce business are better than they are in the store business. Hence, online segment’s share in Costco’s overall profits is higher that its share in overall revenues (~3%). During the quarter, the retailer’s gross margins ticked up 15 basis points year over year to 10.7%, driven by higher margins in food and sundries, as well as rise in e-commerce profits. [3] This looks quite promising considering that margins have declined steadily for most retailers in the U.S. over the last couple of years.
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Notes:
- See the earnings release and Costco Profit Jumps on Stronger Sales, Fee Revenue, The Wall Street Journal, Oct 8 2014 [↩]
- Costco tops Street 4Q forecasts, CNBC, Oct 8 2014 [↩]
- Costco’s Q4 fiscal 2014 earnings transcript, Oct 8 2014 [↩] [↩] [↩]