Costco Is Another Great Addition To Your Portfolio

| About: Costco Wholesale (COST)

Summary

Costco managed to deliver a rising EPS figure during its last quarter despite certain rising costs. The top line remained a major contributor to the EPS.

Growing member base and renewal rates mean that the top line should continue growing. The store expansion plan complements these growing measures.

If costs remain controlled, these factors should help Costco deliver returns to its shareholders.

While Costco Wholesale Corp (NASDAQ:COST) may have given a price return of 4% during the last year, that doesn't mean that the world's fourth largest goods retailer has little upside to offer in the future. The company literally invented the warehouse club retail model, which relies on delivering supply-chain efficiencies, bargaining power for consumers, a no-frills shopping environment, and average mark-ups that cheer up shoppers.

Costco's warehouses are approximately three acres in size, and they sell over 3,000 items each. The techniques used by the company have allowed it generate more sales as we will see in this article. Before we begin, let's examine the company's recent performance.

Latest Quarterly Performance

Sales for Costco increased 7% to $25.2 billion driven by a 4% increase in comparable sales and incremental sales at warehouses. The comparable sales increase was due to increased number of visits from consumers indicating the company's strength in the retail sector. These figures were negatively impacted by changes in the Canadian currency relative to the US dollar and decreases in the price of gasoline. The company opened four new stores with equal proportion being given to domestic and international expansion.

Membership revenues followed a similar trend and increased with higher registration and new warehouses together with increased penetration of the higher-fee paying executive membership program.

The gross margin decreased by 5 bps owing to factors which included the gasoline impact. However, looking into the company's core merchandising area (food and sundries etc), it becomes evident that the margin improved by 7 basis points. While the complete margin results matter, certain temporary macro factors distort short-term results. Therefore, this wasn't something to worry too much about for the long run.

SGA expenses rose due to stock compensation costs in addition to modernizing the information systems, most of which were based in the US. Despite these cost increases, diluted earnings per share rose by 288 bps to $1.07. All in all, the quarter went smoothly with nothing major or material happening to have a significant impact on the company's future potential.

With regards to the company's future, some key measures identify the qualitative factors offered by Costco. While new membership sign ups were up by 100 bps during the last quarter, another tool to identify growth is the renewal rate at which consumers sustain their membership. Costco's US and Canadian renewal rate for the latest quarter stood at 90.6%, with the figure reaching 87.3% on a global scale.

Costco is also increasing its penetration in the executive membership program. Paid executive members totaled close to 14.4 million last quarter, reflecting an increase of over 300,000 new executive members or 26,000 new members per week. These members make up over two-thirds of the company's sales, so this chunk is important to consider, especially given the current renewal rates; these growing numbers mean that top line should continue to grow.

Store expansion is also on the rise. By the end of the third quarter, Costco opened 20 stores during the present fiscal year. Recently, it opened its first store in Seville, Spain along with expanding its presence in Australia, Korea, and Japan.

By the end of this fiscal year, Costco will have opened six more locations; four in the US, one in Canada and one in the UK. This will bring the total yearly openings to 30 with only one closing in Acapulco. I believe a major chunk of growth may come from these new store openings because certain areas, such as Spain, are less familiar with the warehouse store concept and membership culture. In the beginning, sales from these stores are likely to be higher since Costco will offer better rates gained through buying in bulk.

Last but equally important, expansion of choice offered within the stores may bring in customers who shop for those items elsewhere. Costco has now added a few new categories such as apparel and health and beauty items. To improve shipping time, the company now ships from more than one depot and this includes many big ticket items as well.

Bottom Line

Costco's warehouse model is critical to its success. Though food accounts for most of the in-store traffic, investors should know that in order to get to the food, shoppers have to pass by branded merchandise that might appeal to their interests. This tactic pushes consumers to buy those items since they are available at attractively lower prices. In order to further maintain the membership interest in goods, these brands are changed often.

Altogether, these factors explain why Costco should continue to offer premium returns in the future if costs remain under control. The company presently operates at a debt to equity of 0.4x, lower than that of the industry. Therefore it can take on leverage, if needed. I don't see any material defect in the company's performance capability, therefore the company receives a strong buy rating.

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