Costco’s Steady Growth To Continue In Q2 Fiscal 2014

by Trefis Team
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The largest warehouse club in the U.S., Costco (NASDAQ:COST), is scheduled to release its Q2 fiscal 2014 earnings on March 6. (Fiscal years end with August.) In its monthly press releases, the company reported 5% and 6% comparable store sales growth during December and January respectively, excluding the negative impact of foreign currency fluctuations and lower gasoline prices. [1] [2] Considering that the U.S. retail market was particularly weak during these two months, this growth is impressive. We expect a steady rise in the retailer’s sales in February as well.

Costco’s growth is being fueled by an increase in its membership base driven by its volume-discount model, which is all the more attractive with the prevailing economic weakness. In the present environment, U.S. buyers have become extremely value conscious due to slow job growth, increased taxes, higher healthcare costs and high gasoline prices. As a result, they are looking for ways to save money and Costco provides them with the best shopping alternative. Therefore, we believe that the company’s membership base will continue to grow in the second quarter of fiscal 2014.

Our price estimate for Costco stands at $124, implying a premium of more than 5% to the market price.

See our complete analysis for Costco

Positive Growth Despite The Weak Retail Environment

According to ShopperTrak, U.S. foot traffic declined by 17.7% in December 2013 as compared to the same month last year. [3] Weak consumer confidence along with the adverse weather conditions kept buyers away from stores. This trend continued in January as retail sales fell by 0.4% from a month earlier, marking the nation’s steepest retail sales decline in more than a year. [4] Apart from the severe cold and winter storms, this can be attributed to a pullback in consumer spending on account of slow job growth, increased taxes and weak wage hikes. Over the past year, the increase in U.S. wages has lagged behind the inflation rate. [4]

Despite the weak retail environment, Costco’s comparable sales in the U.S. increased by 5% during the months of December and January. Since buyers can save up to 55% while shopping at warehouse clubs, the weak economic environment appears to be favoring Costco’s growth. [5]

While the retailer’s growth is impressive, we believe that it could have been stronger if Costco’s online channel was big. In December, as bad weather prevented store shopping, consumers stayed home and bought more online. As a result, there was a heavy surge in online orders. This is evident from the fact that United Parcel Service (NYSE:UPS), which is one of the biggest player in e-commerce delivery, struggled to ship orders on time. [6] However, since Costco earns only 2.5% of its revenues from online business, it might not have enjoyed this trend. Nevertheless, it will be interesting to see how the retailer’s online business performed during the quarter.

Rise In Membership Base Is Helping Costco’s Results

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 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. We believe that the rise in number of new membership signups in 2013 was driven by the sluggish economic growth, which has made the U.S. consumers more cost conscious. Apart from new membership signups, membership renewal rates also remained strong throughout last year. 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. The business member renewal rate increased to 94% at the end of the fourth quarter from 93.9% at the end of Q3 and renewal rate for Goldstar members rose to 89.1% from 88.9%. In Q1 fiscal 2014, Costco’s membership income increased by $30 million as compared to Q1 fiscal 2013 and an additional $8 million due to membership fee increase. Its North American renewal rates reached 90% from 89.9% in Q3 fiscal 2013. The renewal rate in international markets also remained strong at 87%. New membership signups rose by a healthy 17% and the number of executive members increased by 330,000.

Executive members play an important role in driving Costco’s sales as they represent one-third of Costco’s overall customers and two-third of its revenues. These members pay $110 as membership fee (as opposed to $55 paid by other members) to get 2% (maximum of $750) annual rewards on their purchases. Interestingly, the proportion of executive members in the overall membership base has been rising historically. Back in 2009, they accounted for 33% of Costco’s total members and the figure increased to 38% in fiscal 2013. Even in Q2 fiscal 2013, while the total number of members increased by 1%, executive members grew by 1.4%. In Q4 fiscal 2014, more than 250,000 customers joined the warehouse retailer as executive members.

Historically, Costco’s comparable store sales growth has mainly come from an increase in the number of members as the average spent per customer has increased by less than 1% annually. Therefore, growth in Costco’s membership base will be an important factor to watch out for in the upcoming results.

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Notes:
  1. Costco Wholesale Corporation Reports December Sales Results, Costco, Jan 9 2014 []
  2. Costco Wholesale Corporation Reports January Sales Results, Costco, Feb 6 2014 []
  3. Retailing Today: December 2013, ShopperTrak, Jan 8 2014 []
  4. Growth Shows Signs of Slowdown, The Wall Street Journal, Feb 13 2014 [] []
  5. Best Warehouse Store: BJ’s, Costco or Sam’s Club?, Yahoo Finance, Jan 6 2013 []
  6. Behind UPS’s Christmas Eve Snafu, The Wall Street Journal, Dec 26 2013 []
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