Costco Overcomes Deflationary Pressure, Ups Earnings

Wholesaler switched to Visa, replacing long-term alliance with American Express

c1Costco Wholesale Corp. (NASDAQ: COST), the second-largest global retailer, announced its Q4 FY16 and full year FY16 financial results on September 29th, 2016.

The Issaquah, Washington-based Company, together with its subsidiaries, operates membership warehouses. The company offers branded and private-label products in a range of merchandise categories such as packaged foods, candy, tobacco, alcoholic and nonalcoholic beverages, and cleaning and institutional supplies, appliances, electronics, health and beauty aids. The company also operates gas stations, pharmacies, food courts, optical dispensing centers, photo processing centers, and hearing-aid centers; and engages in the travel business. In addition, it provides gold star (individual) and business membership services. Costco operates under three segments: U.S., Canada, and Other International. Read more about Costco’s financial details below.

Q4 FY16 financial highlights

During Q4 FY16, Costco’s net sales, excluding membership fees, grew 2% to $35.73 billion from $34.99 billion in the year-ago period, despite headwinds from cheaper fuel, currency fluctuations, wage increases for its store workers, and falling grocery prices.

During Q4 FY16, Costco’s comp sales remained flat, but rose 3% excluding negative impact from lower gas prices and the strong dollar. Same-store sales were down 1% in the U.S., up by 2% in Canada, and down by 2% in the rest of the world. Combined sales, including sales of gasoline, were flat. Excluding gasoline sales and currency translation effects, US same-store sales rose 2%, Canadian sales rose 5%, and international sales rose 1%. Combined sales rose 3% during the reporting quarter.

Q4 FY16 is the second time since Costco said it would raise its minimum wage for store workers for the first time in nine years. As a result, operating expenses jumped during the reporting quarter. Costco’s selling, general, and administrative costs jumped 5.6% to $3.7 billion, while merchandise costs grew 1.8% to $31.65 billion.

In June 2016, Costco switched to Visa Inc. (NYSE: V), replacing a long-term alliance with American Express Co. (NYSE: AXP). Management said some 11.4 million co-branded American Express cards, representing about 7.4 million accounts, had been transferred to new Visa Citi cards, and about 85% of those accounts have now been activated with Costco. Another 1.1 million members have applied for the new card since June 20th, 2016.

c2During Q4 FY16, Costco’s membership fees climbed 6% to $832 million from $785 million in the year-ago period, boosted by membership growth as the retailer opened up 10 new warehouses. The Company also succeeded in pushing the executive membership tier that provides bigger shopping benefits in exchange for a higher yearly charge. That segment now accounts for roughly one-third of the membership base, up from 25% a decade ago, and Costco aims to push that figure up to as high as 50% over time. Costco’s operating income also rose to $1.19 billion from $1.15 billion in the year-ago period.

Boosted by lower credit card fees and other terms from its new deal to accept Visa-brand cards, Costco’s profit rose 1.6% to $779 million, or $1.77 a share, despite higher wages, lower gasoline sales, and deflationary pressure on food items including meat and eggs, compared to $767 million, or $1.73 a share, a year ago.

FY16 financial highlights

During FY16, net sales grew by 2% to $116.07 billion from $113.67 billion last year. Combined same-store sales were also flat and sales excluding currency translation effects and gasoline were up 4%. During the year, U.S. same store sales rose 3% with these exclusions, while sales in Canada were up 8% and international sales rose 4%. Comps were 4% for the full year FY16, compared to 7% in FY15 and 6% in each of the previous four years.

Source: Costco
Source: Costco

Even so, Costco continues to lead the industry in same-store growth compared to Wal-Mart Stores Inc.’s (NYSE: WMT) below 2% pace and Kroger Company’s (NYSE: KR) 1.7% growth. A main cause for worry is the slowdown in customer traffic growth. After seven straight years of 4% or higher gains, traffic ticked up by 2.5% during the reporting quarter.

Another positive factor for Costco is that the Company has been working to control costs after wage increases and food deflation put more pressure on its bottom-line, which has enabled it to weather challenges better than some rivals, including Wal-Mart and Target Corp. (NYSE: TGT).

Finally, Costco’s net income for FY16 slipped slightly to $2.35 billion, or $5.33 per diluted share, compared to $2.38 billion, or $5.37 per diluted share, in FY15. The company noted that 2015’s net income included the positive impact of a $57 million tax benefit.

Other highlights

Store/warehouse updates: Costco opened or remodeled 23 locations in 2015, and plans to open about 31 stores in the next 12 months, including 17 in the U.S. and 7 in Canada.

Costco ended FY16 with 715 warehouses, including 501 in the U.S. and Puerto Rico, 91 in Canada, 36 in Mexico, 28 in the U.K., 25 in Japan, 12 in Korea, 12 in Taiwan, 8 in Australia, and 2 in Spain. The Company plans to open 9 new warehouses (including 1 relocation) before the end of calendar year 2016.

Memberships: Costco, with a $55 membership fee, tends to cater to slightly higher income customers. While those shoppers have fared better during the economic recovery, there have been some signs this year they are pulling back over concerns about the election and volatility in the stock market.

Source: Costco
Source: Costco

Guidance for FY17

Costco did not provide any guidance for FY17, but consensus estimates for Q1 FY17 predict EPS of $1.21 on revenues of $28.68 billion. For the full year FY17, EPS is expected to come in at $5.96 on revenues of $128.52 billion.

Stock Performance

c5Costco’s stock stood at $149.47, slipping 0.34%, at the close on Thursday, October 6th, 2016, having vacillated between an intraday high of $150.64 and a low of $149.00 during the session. The stock’s trading volume was at 2,465,536 for the day. The Company’s market cap was at $65.40 billion as of Thursday’s close.

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