Costco Beats On Profits And Shows Significant Revenue Growth Potential
Costco (NASDAQ:COST) reported its Q2 fiscal 2015 earnings that turned out better than expectations. The company reported net earnings of $1.35 per share, a year-over-year increase of 29% that was way ahead of the consensus estimate of $1.17. Costco’s profits benefited from $57 million in tax benefit with regard to February’s special cash dividend, partially offset by $14 million in charges related to the ongoing tax matter. The retailer’s overall revenues increased 4.4% to $27.454 billion, driven by 2% growth in comparable sales and incremental revenues from new stores. Although Costco’s comparable sales growth for the second quarter may not look pleasing, it must be noted that a fall in gasoline prices and the strengthening dollar had a significant negative impact on the company’s growth. Excluding this impact, Costco’s comparable sales growth stood at 8%, which is inline with its growth targets. [1]
Costco’s growth was once again driven by a consistent rise in its member base, which benefited from growth in new membership signups, an increase in the number of executive members, and improvement in renewal rates. In addition, we believe that spending at Costco also went up with the improvement in consumer affordability in the U.S., thanks to the fall in the jobless rate and gas prices. In international markets, where this retailing concept is relatively new as compared to the U.S., the company seems to be performing very well, with a few exceptions.
These results confirm that while Costco’s growth is susceptible to currency fluctuations and gasoline price variations, it is not short on organic growth drivers. There is still enough room to expand in the U.S. and international markets, and the ongoing industry-wide online boom also provides a substantial growth opportunity.
Our price estimate for Costco stands at $130, implying a discount of about 10% to the current market price. However, we are in the process of updating our model in light of the recent earnings release.
See our complete analysis for Costco
Member Base Growth Will Continue To Drive Comparable sales
The primary growth driver for Costco’s comparable sales rise has been its consistently growing member base. During the second quarter of fiscal 2015, new membership signups increased 9% as the company added 700,000 Gold Star members and 100,000 primary business members. Total number of households increased from 41.5 million at the end of Q1 fiscal 2015 to 43.2 million at the end of the second quarter. Overall, the total cardholders increased from 77.5 million to 78.7 million during Q2 fiscal 2015. The number of executive members represent over one-third of Costco’s total member base and accounts for over two-thirds of its overall revenues. Executive members’ proportion in total member base has historically been growing and we expect it either remained same or ticked up a little in the recently concluded quarter.
Membership renewal rates at Costco have been improving slowly for the past several quarters, and this trend continued in Q2 fiscal 2015 as well. The business member renewal rate went up to 94.6% from 94.5% at the end of the first quarter of fiscal 2015. The Gold Star renewal rate also improved slightly to 89.9% from 89.8% during the same period. Overall, renewal rates in the U.S. remained at 90.7%, while worldwide they improved 60 basis points to 87.9%. [2] It is interesting to note that at the end of same quarter last year, Costco’s U.S. and international renewal rates stood at 90.4% and 86.8%, respectively, and it had 73.4 million card holders. These figures clearly indicate a significant rise in Costco’s customer base over the past year. As Costco continues to expand in the U.S. and abroad, and the warehouse model gains further popularity, the number of card holders should continue to rise, driving the warehouse giant’s comparable sales growth in tandem.
Steady Expansion Will Result In Incremental Revenues
Costco Operates close 671 stores worldwide, out of which around 470 are in the U.S. and the remaining are spread across the retailer’s international markets. With less than 500 stores in the domestic market, there is a lot of room for Costco to expand. However, rather than expanding aggressively, which can lead to self-cannibalization, the company is identifying lucrative markets for its expansion and hence is adding to its store base slowly. While the company did not open any stores during the second quarter, it opened nine outlets in the first and is on track to add another 20 outlets by the end of fiscal 2015. [2] About half of the stores scheduled for the latter half of the year are planned for U.S. and remaining are planned for Japan, Australia, Korea, Mexico, Taiwan and the U.K. [3]
We believe that Costco’s revenue growth will remain steady in the future, as it continues to open stores in relatively new and under penetrated markets. Within the U.S., Costco’s presence is highly concentrated around California, which indicates substantial room for growth elsewhere in the country. In international markets, the company has not been too aggressive in entering new countries and expanding in the existing one. The retailer appears to be very selective in choosing the locations for expansion as a new store requires significant capital. Before opening an outlet, Costco looks to make sure that customer response will be good. For instance, the warehouse retailer has started its operations in China through an e-commerce partnership with Alibaba (NYSE:BABA), and has seen tremendous success so far. [4] Few years down the line, Costco may look to open physical stores in China, where it had not shown any significant interest so far.
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Notes:
- Costco Wholesale Corporation Reports Second Quarter and Year-To-Date Operating Results, Costco, March 5 2015 [↩]
- Costco’s Q2 fiscal 2015 earnings transcript, March 3 2015 [↩] [↩]
- Costco’s Q1 fiscal 2015 earnings transcript, Dec 10 2014 [↩]
- Costco expands to China with the help of Alibaba’s Tmall, Geekwire, Oct 14 2014 [↩]