Will Better Sales Boost Costco Wholesale's Bottom Line?

Costco Wholesale (NASDAQ: COST  ) reported strong June sales numbers on July 10. While the warehouse giant seems to be extending its lead on Wal-Mart's (NYSE: WMT  )  Sam's Club, some investors are still concerned by Costco's tight margins and recent earnings. While there is no way to tell what Costco's next earnings release, on October 9, will bring, there are reasons for investors to be optimistic that Costco is doing well. 

Source: Costco

June sales numbers were strong
So how strong was Costco's June?  Costco's June same-store sales rose 6% (vs. expectations of 5.4%), on higher gas prices and a strong 7% jump in international comps. If not for a negative foreign currency effect, international comparable sales would have been even higher (8%). The numbers beat analyst expectations across the board. 

In addition to the strong same-store sales, Costco's net revenues soared 10% in June, totaling $10.89 billion. 

Gas inflation: a net positive for Costco
Higher gas prices are typically a good thing for Costco. If you are unaware, Costco earned a whopping $11.2 billion in fuel sales last year. However, the benefit of high gas prices is more than simply the revenues Costco generates on its gasoline sales. 

Costco considers gasoline sales an ancillary business, and it sells it gas at a lower margin than other products. Costco's strategy is to lure customers in with ancillary sales, and keep them at the store to buy other (higher margin) products. There's evidence that this strategy works. In a 2011 issue of The Costco Connection, the company noted that 30% of customers who came to Costco for cheap gas, ended up buying higher margin goods in the store. Costco also points out that membership renewal rates lean higher when gas prices spike; members will renew just for the cheap gas. For more information on this, see the 2011 issue directly, or visit HHC publishing, for a summary on all of Costco's ancillary business benefits. 

We've also seen Costco mention higher gas prices as a catalyst for better profits and membership renewals (after strong quarters), and they've mentioned lower gas prices as the culprit for poor results. As the chart below shows, gas prices have risen in recent months. Could this spike in fuel costs drive traffic, and thus profit, for Costco this quarter?


US Retail Gas Price Chart

US Retail Gas Price data by YCharts

Of course, you can also get cheap gas (with a membership) at Sam's Club but, for whatever reason, customers like Costco more. Fellow Fool Jayson Derrick recently pointed out that Costco has a big lead on Wal-Mart's Sam's Club, when it comes to fuel, as it does anything else. While Sam's Club recently unveiled a cash back fuel incentive, it still had weak -0.6% first-quarter comparable sales.

I actually don't think this discrepancy is due to differences in the gasoline. I think that Costco's store experience is better; customers prefer to shop at Costco over Sam's Club (whether they're buying gas or cereal). If someone is on the fence about a wholesale membership, and high gas prices push them to buy one, they'll probably pick Costco.

Thanks to higher gas prices, I'm expecting a strong new membership number in Costco's next quarter. 

Looking beyond sales
Costco always leads with their sales numbers in earnings releases; it's clear they want investors focused on that. .

Each month, Costco issues a report, like this one, with their monthly sales numbers. They don't mention margins, or anything else in terms of operations. Costco's earnings releases, similarly, lead with sales figures. It makes sense, given that the company has a business model that is built on high volumes and tight margins. Sales and membership renewals are the keys for Costco; yet, we still need to know if these sales will fall to the bottom line. 

Analyst's are only expecting a very small increase in EPS for Costco's next quarter, but its sales are much higher (year over year). If we look at Costco's sales for June of last year we see same-store sales of 6% and net sales of $9.92 billion. That means that this June's net sales are nearly a billion dollars ahead of the same period last year. This lead has expanded since May. 

The hard part, in determining what earnings will be, is that Costco's operating margin has slid a bit. This metric measures profitability after most operating costs (labor, etc.) are factored in, but before interest and taxes are accounted for. As the chart below shows, things have become a bit tighter for Costco. 

COST Operating Margin (TTM) Chart

COST Operating Margin (TTM) data by YCharts

If both of these trends (much higher sales and slightly tighter margins) are to continue, I think Costco will still do fine. Analysts are only expecting an earnings boost of 3 cents per share for Costco in the fourth quarter, easily attainable if these positive sales trends continue. 

Stick with Costco
Costco may be working on a strong quarter. It doesn't really matter if they meet analysts short-term expectations. What matters is that Costco's growth story, and the health of its underlying business, appear to be intact. 

Costco looks strong compared to most retailers, because it gives customers value and quality they can't get elsewhere. That's why they're fairly well in this tight retail environment. I think June's sales numbers are a positive sign, and I expect that Costco's business results (sales and earnings) will be satisfactory for the foreseeable future.

Leaked: Apple's next smart device (warning, it may shock you)
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 3034507, ~/Articles/ArticleHandler.aspx, 9/2/2015 10:45:29 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Adem Tahiri

Like what you've read? Subscribe to this feed for even more--free. I'm addicted to learning everything there is to know about retail stocks, consumer and labor trends, and behavioral finance; join me here and on twitter: @adem_tahiri I still believe that great investments are born when a strong business meets a game changing trend. Blog:

Today's Market

updated 1 hour ago Sponsored by:
DOW 16,351.38 293.03 1.82%
S&P 500 1,948.86 35.01 1.83%
NASD 4,749.98 113.87 2.46%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/2/2015 4:00 PM
COST $140.42 Up +2.12 +1.53%
Costco Wholesale CAPS Rating: *****
WMT $64.44 Up +0.62 +0.97%
Wal-Mart Stores CAPS Rating: ***