Costco’s Q4 Met Expectations, But The Stock Fell On Margin Concerns, Flaw In Financial Controls

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Costco‘s (NASDAQ:COST) fiscal fourth quarter revenue came in ahead of market expectations while earnings per share came about in line with consensus. However, the stock traded down as gross margins narrowed despite higher sales and the company disclosed a material weakness in its internal controls. The gross margin compression was largely due to the company’s investments to boost online sales through services like same-day delivery and automated fulfillment centers. In addition, a higher percentage of total sales also came from gasoline, which is generally less lucrative for the company compared with the merchandise in its stores. Overall, Costco’s revenue increased 5% year-over-year (y-o-y) to around $44.4 billion in the fourth quarter, driven by growth in membership fees and a 10% increase in comparable sales. The retailer reported net earnings of $2.36 per share, up 13% y-o-y.

Our $236 price estimate for Costco’s stock is slightly below the current market price. We have created an interactive dashboard on what to expect from Costo’s fiscal Q1, which outlines our forecasts for the company’s next quarter. You can change expected revenue, operating margin and net margin figures for Costco to gauge how it will impact expected EPS for the fiscal first quarter. We expect Costco’s revenue and earnings to grow in Q1, primarily due to the company’s value offerings and high membership renewal rates, coupled with cost and productivity savings.

Growth In Comparable Sales, Membership Fees

The company’s comparable store sales during the fiscal fourth quarter increased by 10%, including the impact of gasoline prices and currency effects, largely driven by a 11% comparable sales growth in the U.S. and 6% in Canada. Excluding gasoline and currency fluctuations, combined comparable sales increased by 7%, driven by 8% growth in the U.S., a 5% rise in Canada and 7% growth in other international markets. In terms of categories, foods and hardlines (tires, hardware, health and beauty aids) were up slightly, while soft lines (apparel, housewares) declined marginally in Q4. Additionally, Costco’s growth was driven by both traffic and average transaction size growth. The company’s fiscal fourth quarter traffic was up 4.9% both worldwide and within the U.S. Overall, the company’s continued growth momentum confirms that it should be able to continue to see healthy traffic at its brick and mortar warehouses despite stiff competition in the grocery sector in the long run.

Costco’s membership revenue grew 6% y-o-y to $997 million, due to new sign-ups and increased penetration of the company’s higher-fee Executive Membership program. Currently, Costco’s member renewal rates are 90.4% in the U.S. and Canada and 87.9% worldwide. Meanwhile, on the e-commerce front, Costco’s online sales increased 26.2% y-o-y in the quarter. And on the cost side, the company’s selling, general and administrative (SG&A) expenses increased 3% y-o-y to around $4.3 billion due to increased payroll expenses, higher IT expenditures and growth in e-commerce initiatives.

Looking Ahead

In the Q4 earnings call, Costco stated that it uncovered a material weakness in its internal controls pertaining to its IT systems relating to financial reporting. The company expects to resolve this issue over the next twelve months. Further, Costco also mentioned that it plans to open its first Chinese location, in Shanghai, next September.

Consensus estimates for the company’s fiscal first quarter call for earnings of $1.63 per share and revenues of $34.1 billion, implying growth of about 10% and 8%, respectively. We forecast the retailer to report revenues of close to $34.4 billion in the first quarter.


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