Costco’s Earnings: Core Value Proposition Will Keep Its Sales Humming

by Trefis Team
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Costco (NASDAQ:COST), the largest warehouse club in the U.S., is scheduled to release its Q4 fiscal 2013 earnings on October 9. [1] In a recent press release, the company stated that its comparable store sales increased by 5% during the quarter. [2] What’s even more pleasing to see is that the retailer sustained its growth momentum when the economic environment was particularly weak. Costco’s attractive bargains and growing customer base along with its focus on executive members and private label brands are helping it drive comparable store sales growth. We believe that the prevailing economic weakness in the U.S. is further helping the retailer attract value-conscious customers. However, foreign currency fluctuations and changes in gasoline prices continue to negatively impact its growth. While Costco reported 4% growth in international comparable store sales, the figure was 7% excluding the impact of gasoline and foreign currency fluctuations.

See our complete analysis for Costco

Costco’s Value Proposition Is Leading To Membership Growth

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%. [3] [4] Moreover, with concrete floors, simple shelves and display boxes, Costco keeps costs to a minimum. The retailer has strong negotiating power over its vendors as it buys large quantities of fewer SKUs. It regularly changes the brands it offers by buying brands that have larger inventories to get more discounts. [5] This way customers always find something new at Costco. These strategies allow the retailer to offer merchandise at compelling prices, attracting buyers to become Costco members.

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. More than 1.6 million new members joined Costco during the first two quarters of fiscal 2013 and it saw a rise of 19% in new membership signups in the third quarter. [6] The membership renewal rates have also improved gradually. From 89.7% in Q1 fiscal 2013, Costco’s membership renewal rate in the U.S. increased to 89.8% in the second quarter and reached 89.9% in the third. [6] We expect this trend to have continued in the third quarter as U.S. buyers remain value-conscious due to prevailing economic weakness.

Growing Executive Member Base & Private Label Brands Are Also Helping

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. 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%. Although the executive member penetration declined slightly by 2 basis points in the third quarter, it is likely to increase in the future as Costco continues to provide executive membership in international markets. [6]

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. The retailer has been increasing the share of these brands within its overall product range by 0.5%-0.75% annually. 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.

Ultimately, This Translates Into Steady Growth

Costco’s growth has remained on track for the past several quarters irrespective of the state of the U.S. economy. During the holiday season last year, while the industry wide sales remained weak, Costco registered robust growth. Its comparable store sales increased by 5% in the U.S. and 6% internationally in Q2 fiscal 2013. In the following quarter, the retail environment in the U.S. remained challenging due to payroll tax increase, delayed tax refunds and a prolonged winter. Costco again remained steady with 5% comparable store sales growth in fiscal Q3. The recently concluded quarter has been particular weak for a number of retailers including Wal-Mart (NYSE:WMT), Target (NYSE:TGT) and Macy’s due to weak consumer spending. However, Costco sustained its growth momentum registering 5% comparable store sales growth in the fourth quarter of fiscal 2013.

Our price estimate for Costco stands at $117, which is in line with the market price.

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Notes:
  1. Costco’s Investor Relations []
  2. Costco Wholesale Corporation Reports August, Fourth Quarter and Fiscal 2013 Sales Results, Costco, Sept 5 2013 []
  3. Costco’s Unorthodox Strategy To survive The Big Box Apocalypse, Business Insider, Mar 7 2013 []
  4. How Costco Became The Anti-Wal-Mart, The New York Times, July 17 2005 []
  5. Inside Costco: Secret’s Of America’s Favorite Stores, abc news, March 29 2010 []
  6. Costco’s Q3 fiscal 2013 earnings transcript, May 30 2013 [] [] []
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