What’s In Store For Costco In Fiscal 2016?

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In the wake of  its recent earnings release, Costco‘s (NASDAQ:COST) stock has been inching upwards and has almost reached its 52 week high. The warehouse club ended fiscal 2015 on a strong note as the company grew its comparable sales and revenues by 1% during the year, taking the top line to a little under $114 billion. While these growth numbers, as reported, are not that impressive, muffled as they are by both currency effects and subdued gas prices. Adjusting for these factors, comparable sales growth for the year stands at a more respectable  7%. Costco’s net income also increased by 15% compared to the last fiscal, to $2.4 billion.

In the year ahead, we expect both oil prices and currency headwinds to ease out. Therefore, top line growth is likely see a recovery sooner rather than later, while margins might stay on the lower side driven by Costco’s investments in technology, eventually recovering towards the end of fiscal 2016.

Our price estimate for Costco stands at $141, about 5% below the current market price.

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See our complete analysis for Costco

Membership Expected To Grow Driven By Expansion

Costco’s membership fees came in at $2.5 billion in fiscal 2014, an increase of $105 million or 4.3% compared to the previous fiscal year. While renewal rates remain strong at 91% in the U.S. and Canada and 88% internationally, the company is also expected to benefit from new sign-ups, going forward. At the end of the fiscal year, the total number of memberships stood at about 81 million, 20% of which are executive memberships who pay an additional $55 for a 2% reward on most purchases.

Given Costco’s expansion going forward, the number of new sign-ups will further boost earnings. For example, in Asia, new warehouses typically see an average of 30,000-40,000 signups in the first two to three months ((Costco’s Global Expansion… With a Twist, July 14, 2014, Motley Fool)). In the recently ended fiscal, the company added 22 warehouses, half in the U.S. and half in rest of the world, taking the total warehouse count to 686. Before the end of this calendar year (i.e., in the next three months), Costco will open an additional 12 warehouses (and a total of 32 in fiscal 2016).

Considering the average membership fee per warehouse of $3.7 million, store openings due in 2015 offer a revenue potential of $44 million in incremental membership fees (6% of the current annual fees earned). More importantly, the impact these new sign-ups will have on the net income will be more meaningful as most of the fee revenues trickle down to the bottom line.

IT Investments Will Keep Margins Down

Costco online currently operates in four countries; U.S., Canada, UK and Mexico. For the fiscal year, total sales through the digital channel amounted to $3.5 billion, a growth of 20% for the year. Growth in online sales seen this fiscal was driven by the company’s investments in technology. The company, for long, had been running on legacy systems, many of which were developed in-house. As they grew strained with time, the company decided to make significant upgrades to the systems while also establishing an online presence.

This fiscal year, incremental costs on IT led to an increase in SG&A expenditure by $75 million or 17 basis points, as a percentage of total revenues. While these investments will continue into the next fiscal year, they are expected to taper off towards the second half of the year. Therefore, in addition to an uptick in sales, we might also see a slight  improvement on the margins front in the latter half of the year.

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