Costco Misses Earnings: Time to Sell or Buying Opportunity?

Is the recent earnings miss from Costco a buying opportunity or a reason to sell?

Mar 8, 2014 at 8:00AM

Cost Image

Source: Costco.

Costco (NASDAQ:COST) fell by more than 2.7% on Thursday after the company announced lower-than-expected earnings for its fiscal second quarter of 2014. Should you capitalize on the opportunity to invest in a solid company at a discounted price or will things continue to get worse for Costco in the coming quarters?

The numbers
Both sales and earnings came in below expectations. Revenues increased 6% versus the prior year to $25.76, which was lower than the $26.65 billion forecasted on average by Wall Street analysts. Earnings per share were $1.05 during the period, also below estimates of $1.17 per share and falling 4.5% versus the same quarter in the prior year.

EPS during the same quarter in 2013 were positively affected by $0.14 in one-time tax benefits. Still, EPS declined during the quarter even when adjusted by these considerations.

Management attributed the weakness to several factors, including a highly promotional retail environment especially during the holiday period, weaker margins in fresh foods, and unfavorable currency fluctuations. According to management, most of the softness in the quarter happened during the holidays: "The first four-week period of the quarter represented the majority of earnings underperformance in the quarter."

The context
It's important to consider that performance does not look quite as dismal when adjusting for transitory and outside factors like exchange rate volatility and fuel price fluctuations. Comparable sales during the four weeks ended on March 2 grew by 4% in the U.S. and 5% in international markets for a total company level growth rate of 4% in comparable-store sales when leaving fuel and foreign exchange aside.

This is certainly much better than the performance reported by rival Wal-Mart Stores (NYSE:WMT) during the last quarter. The company reported a 0.4% decline in same-store sales in Wal-Mart U.S. during the 14 weeks ended on January 31. Comparable-store sales at Sam's Club, perhaps Costco's most direct competitor, declined by 0.1% during the period when excluding fuel.

Target (NYSE:TGT) was hurt by the data breach that affected the company on December 19, so the company's performance reflected specific problems in addition to industry trends. However, sales during the three months ended on February 1 declined 3.8% versus the same period in the prior year, while EPS collapsed by 44.5%. Even if it's hard to reach general industry conclusions from Target's performance considering the circumstances, the data is certainly not very encouraging.

It's no secret at all that factors like a harsh weather, an intensely competitive environment, and competition from online retailers are putting a lot of pressure on the retail industry lately. Sectors like department stores and electronics retailers are finding it hard to sustain sales and profit margins, so it really shouldn't come as a big surprise to see discount retailers like Costco, Wal-Mart, and Target facing similar challenges.

The opportunity
No company is completely immune to industry conditions, and Costco is clearly linked to consumer spending. However, the company makes most of its profits from membership fees, not margins on product sales. This means that Costco will be fine over time as long as it continues retaining and growing its membership base.

Membership fees increased by 4% during the quarter to $550 million, but currency headwinds represented a big drag during the quarter. Membership fees excluding foreign exchange impact increased by a healthy 7% annually to $563 million.

New memberships increased by 13% during the quarter, and retention rates were as strong as ever, with a global retention rate of 86.4% and a business member renewal rate of 94.3%.

Customers remain loyal to Costco, and the company continues to expand its store base with 30 new openings planned for the current fiscal year. Costco still has room for expansion in the U.S. considering demand trends, and international growth is still in its first stages.

The company is opening new stores in Canada, U.K., Korea, Japan, Australia, Mexico, and Spain this year. If it can replicate at least partially in international markets the level of success it has achieved in the U.S., then it has abundant room for growth over years to come.

Bottom line
No company exists in a vacuum, and factors like climatic conditions, an aggressive competitive landscape, and foreign exchange fluctuations had a negative effect on Costco's performance during the last quarter. However, it is still as sound as ever in terms of customer loyalty and it has a lot of room for expansion in the coming years. Recent weakness in Costco is no reason to sell the stock. Far from that, it looks like a buying opportunity for investors.

You know the retail industry is dramatically changing, but do you know how to profit?
To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.

Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers