Costco (COST) continued its revenue growth in fiscal Q2 2013 driven by higher membership fees, new membership signups and food price inflation. Interestingly, its customers were not impacted too much by the payroll tax increase since the retailer caters to middle-upper income and upper income demographics. The retailer’s revenues and comparable store sales increased by 8% and 5% respectively during the quarter. Going forward, we expect Costco to do well due to the rise in membership renewal rates and increasing penetration of executive members. The growing share of private label brands, international expansion and e-commerce strategy will further aid growth.
Second Quarter’s Performance
Costco’s Q2 results reflected positive contributions from the 10% membership fee increase that the retailer implemented in November 2011. Total membership fee revenues in the second quarter stood at $528 million, up 15% over the same quarter last year. The significance of membership fees is evident from the fact that it constituted about 97% of Costco’s Q2 net income. Additionally, Costco witnessed 900,000 new membership signups during the quarter, partially influenced by the gasoline price rise. Growth in the customer base is the main driver for Costco’s comparable store sales growth as average revenue per member (ARPU) has remained fairly stable over the last few years. The company also reported that grocery sales, which constitutes about 50% of its revenues, grew strongly due to food price inflation.
What Does The Future Hold?
Improving Membership Renewal Rates And Penetration Of Executive Members
Apart from new membership signups, the membership renewal rate is also an indicator of customer confidence. While this figure for North America remained flat at 89.7% during the first quarter, it improved slightly to 89.8% in Q2 fiscal 201s. Similarly, the membership renewal rate for international markets increased to 86.5% in Q2 after remaining stable at 86.4% for two consecutive quarters. The rising renewal rate despite a 10% rise in membership fee is an encouraging sign for Costco. We expect this figure to further improve as the U.S. buyers look to save money and adoption of the warehouse shopping model grows internationally.
Executive members pay $110 as a membership fee (as opposed $55 paid by the other members) to get 2% (maximum of $750) annual rewards on their purchases. They represent one-third of Costco’s overall customers and two-third of its revenues. The proportion of these members in Costco’s overall membership base has been rising historically, increasing from 33% in fiscal 2009 to 38% in fiscal 2012. Even in Q2 fiscal 2013, while the total number of members increased by 1%, executive members grew by 1.4%. With the recent increase in rewards cap from $500 to $750, we expect this trend to continue.
Increasing Proportion Of Private Label brands
One of the unique selling points of Costco is its private label brands such as Kirkland Signature. According to the company, these brands are comparable in quality to national brands and are often cheaper. The retailer has been increasing the share of these brands within its overall product range by 0.5% – 0.75% annually. At the end of Q2 fiscal 2013, private label brands accounted for 20% of Costco’s total merchandise.
International Growth And E-Commerce Strategy Will Strengthen Costco
Looking at average revenue growth for the past four years, we note that Costco’s international business (15%) has grown done substantially faster than its U.S. business (5%). In Q2 fiscal 2013, a significant proportion of new membership signups came from Australia and Asia. It’s interesting to note that Asia’s contribution was encouraging despite the opening of just one store in the first half of fiscal 2013. The retailer now plans to add six stores in the region over the next two quarters. Historically, Costco has seen 20,000-60,000 membership signups on the opening day of Asian stores, hence it makes sense to continue expanding there. Overall, the retailer plans to add 14 stores in the next half and only four of them will be in the U.S.
Costco offers distinct products in its stores and e-commerce site to keep its customers interested. The company stated that about 80%-90% of its products offered online do not overlap with the store inventory. This allows the retailer to operate two distinct channels without having to worry about the sales of one cannibalizing the sales of another.
Our price estimate for Costco stands at $113, implying a premium of about 10% to the market price.
Disclosure: No positions.