Costco’s Earnings Preview: Rise In Membership Will Lead To Steady Growth

Costco (NASDAQ:COST), the largest warehouse club in the U.S., is scheduled to release its Q1 fiscal 2014 earnings on December 11. (Fiscal years end with August.)   In a recent press release, the company stated that its comparable store sales increased by 5% during the quarter. ^[1] Sales for the quarter were $26.8 billion, up 6% over the prior year.  The retailer has seen similar growth for the past several quarters and its steady performance amid a weak retail environment is quite promising.

Costco’s growth is being fueled by an increase in membership base which is being driven by 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.

Since Costco has already reported its sales figures for the quarter, we will focus on its membership base, which is one of its key growth drivers. Alongside, we will keep an eye on the retailer’s online business since it is an important channel for the company’s long term growth.

Our price estimate for Costco stands at $125, which is just ahead of the market price.

See our complete analysis for Costco

Membership Base Likely To Grow

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%.

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, 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 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.

Online Business Will Be In Focus

Costco’s growth in the U.S. depends on its ability to expand as well as sell more through its existing stores. While the retailer’s comparable store sales have grown steadily over the past few years, its domestic expansion has been slow. Therefore, we believe that its online business presents the most viable growth alternative in the U.S. market. We will closely monitor the direct channel’s performance in Q1 fiscal 2014.

Currently, Costco’ online sales account for only 2% of its overall revenues, suggesting that there is a huge room for improvement. Given the optimistic outlook for the U.S. online retail industry, this might not be a difficult task. During the last two quarters of fiscal 2013, the company’s e-commerce revenues increased by 20% and 15% respectively driven by its e-commerce strategy, website re-platforming and mobile apps. Costco’s main strategy for its online business is to offer distinct products on the e-commerce site to keep its customers interested. About 80%-90% of its products offered online do not overlap with the stores inventory, which enables the retailer to prevent cannibalization of its store sales to some extent.

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1. Costco Wholesale Corporation Reports First Quarter Fiscal Year 2014 and November Results, Costco, Dec 5 2013 [↩]