Costco Outperforms Wal-Mart And Target

| About: Costco Wholesale (COST)

Even as Wal-Mart (WMT) remains challenged, wholesaler Costco (NASDAQ:COST) continues to report strong results. Revenue increased 8% year-over-year to $24.8 billion, falling slightly short of consensus estimates. Earnings jumped 37% year-over-year to $1.24 per share, roughly in-line with consensus expectations. Earnings included a one-time $0.14 per share benefit, net of which earnings still grew 22% year-over-year.

Although revenue growth was only 8%, membership revenue jumped 15% year-over-year to $528 million. Membership revenues are driven by fantastic renewal rates, which in the U.S. and Canada totaled 93.9% for business memberships and 88.8% for Gold Star memberships. With renewals so strong, the company has been able to easily pass on price increases, saying:

Continued increasing penetration of the Executive membership, which is the roughly $110 a year fee.

And we're still, of course, benefiting from the $5 and $10 membership fee increases that began a lot of a year ago in both the U.S. and Canada. And of the $69 million increase year over year in membership fees, right at a half of it, or about $35 million, was due to the fee increase.

Costco also noted that the benefit from membership prices increases will continue during fiscal year 2013 and the first half of fiscal year 2014. We also wouldn't be surprised to see the company capitalize more on its underpricing in the next few years if retention rates continue to grow.

Same-store sales for the second quarter were strong, growing 5% during the quarter (ex-fuel) in the United States and growing 4% internationally (ex-fuel/foreign exchange fluctuations). Consumers are responding to the firm's value proposition, and whether it's the in-store experience or slightly more affluent customer, the firm is doing a wonderful job driving traffic. Even February, which Wal-Mart previously noted was quite weak, was terrific for Costco, as same-store sales jumped 6% domestically and internationally.

Merchandise gross margins were basically flat year-over-year, as were fixed costs, as SG&A came in at 9.7% of sales versus 9.68% of sales in the year-ago period. We aren't worried about the cost structure increasing, even though the company anticipates technology spending will raise costs during fiscal year 2013.

Looking ahead, we think the company could realize some small gains on the merchandise margin side as its private label, Kirkland, becomes a larger percentage of the product mix. According to management:

You know, private label is in the low 20s, and continues to grow. And you know, when we talk about aspirational numbers, we'd like to see a three in front of it instead of a two. But I don't know how long that takes. Certainly we keep adding new items. In the last couple of years, we've certainly added several items in apparel and canned goods, those types of items.

On the expansion side, the firm hopes to open 28 new locations which would add 4.5%-5% in square feet, with 13 new stores in the US, 3 in Canada, 3 in the UK, 7 in Asia, and 1 in both Australia and Mexico. Management tempered expectations of a European expansion, noting how difficult it is to get permits, real estate, and opening stores in countries like France and Spain.

Moving to the balance sheet, we're comfortable with Costco's increased leverage because of how cheap its debt is and how much cash the business continues to throw off. The company has replenished its cash balance after paying a $7 per share special dividend, and we think the firm has robust liquidity at this time.

Overall, we thought the quarter was fantastic, and we think Costco is an absolutely wonderful business with strong long-term prospects. Unfortunately, the market is well aware of this, hence we believe shares look fairly valued at this time. Costco also trades at a premium to its peers like Wal-Mart and Target (NYSE:TGT), but it continues to be one of our favorite retailers. We won't hesitate to add shares to the portfolio of our Best Ideas Newsletter at the right price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.