It’s hard to be a leader. Costco Wholesale (NASDAQ: COST) has developed a reputation for dominating the big-box retail space, with a loyal group of customers who count on getting bargain deals when they shop at its warehouse locations. Even as the growing trend away from brick-and-mortar locations toward e-commerce has punished many of its competitors, Costco still has managed to find ways to grow and keep its shoppers coming in through its doors.
Coming into Thursday’s fiscal third-quarter financial report, Costco investors were looking forward to great news on the sales front, especially after two strong monthly reports that showed attractive levels of comparable sales. Yet even though Costco’s top-line and bottom-line results exceeded the consensus forecasts, some investors still seemed to find fault with the warehouse retail-giant’s performance, and it’ll be interesting to see whether pressure persists in the days and weeks ahead.
A strong showing from Costco
Costco’s fiscal third-quarter report extended the retailer’s streak of good results. Total revenue of $32.36 billion was higher by 12% from year-ago levels, outpacing the 10% growth rate that most of those following the stock were looking for from Costco. Net income rose a more modest 7%, to $750 million, and that worked out to $1.70 per share, beating the consensus forecast by $0.01.
In reality, Costco’s bottom-line performance was better than those numbers suggested. Last year’s fiscal third quarter included an $82 million benefit related to the declaration of Costco’s special $7 per-share dividend. When you adjust last year’s results for that benefit, earnings per share climbed at an impressive 21% pace.
As most had foreseen, Costco was able to produce very attractive comparable-sales growth. Total company comps rose 10.2%, including gains of 9.7% for the U.S. market, 11.3% in Canada, and 11.8% elsewhere internationally. Those numbers were inflated somewhat by the fact that foreign-exchange markets generally were favorable and rising gas prices also boosted revenue figures in a way that’s somewhat artificial for the retailer.
Yet even when you adjust for those figures, comps still were good, accelerating to 7% growth overall. U.S. adjusted comps were best, rising 7.7%, but showings of 4.8% in Canada and 5.8% in the rest of the world still marked good progress. Costco reported a 37% jump in e-commerce sales, accelerating from its pace of growth three months ago.
As we’ve seen throughout the past year, membership-fee revenue grew at a healthy pace, due in large part to the increases that Costco implemented in 2017. During the fiscal third quarter, membership-related revenue climbed 14%, to $737 million. Store network expansion efforts slowed markedly during the quarter, though, with a single new U.S. location bringing its total count to 750.
Is there anything to worry about for Costco?
You have to look closely at Costco’s numbers to find much fault with the retailer’s business, but there are a couple of things worth noting. One concern is that merchandise-related costs grew more quickly than net sales, reducing gross margin — defined, in this case, by the percentage of net sales left after accounting for merchandise costs — by nearly half a percentage point, to just over 11%.
Costco has always been able to survive on razor-thin margins, with the essentially free money represented by membership fees producing the lion’s share of the retailer’s overall profits. Nevertheless, it’s important for many investors to see Costco maintain the cost discipline that has helped it thrive over the years, while passing through at least the majority of any cost increases to its customers.
The other somewhat surprising issue came from the fact that any positive impact from tax reform for Costco wasn’t evident. The retailer had a $309 million provision for income taxes, representing almost 29% of pre-tax profit. That effective rate was actually higher than the 27% that Costco paid in the year-earlier quarter. It’s too early to draw conclusions from a single quarter’s numbers, but investors will want to see those tax figures fall in order to reap the full benefit of more favorable corporate rates.
Investors didn’t seem satisfied with Costco’s results, and the stock was down almost 2% in after-hours trading immediately following the announcement. The warehouse retailer’s long-term business model remains sound, but some shareholders appear to be looking for any excuse to hold back the stock from climbing any further than it already has since last summer — even though there doesn’t seem to be anything for them to worry about in the long run.
10 stocks we like better than Costco Wholesale
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now… and Costco Wholesale wasn’t one of them! That’s right — they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of May 8, 2018