Image: Costco Wholesale.
For years, Costco Wholesale (COST 0.17%) has given investors solid sales growth and consistent profitability. Yet even though the big-box warehouse retailer still has a loyal customer base and dominates its segment of the retail industry, Costco has still struggled to keep its growth rate up in recent quarters. Coming into its fiscal second-quarter financial report on Wednesday night, Costco investors wanted to see at least modest gains in the company's top and bottom lines. Instead, Costco saw a surprise drop in adjusted earnings per share and continued to watch its comparable-store sales slow. Let's look more closely at the latest from Costco Wholesale and what it means for the company going forward.
Costco misses again
Costco's fiscal Q2 report marked the second straight quarter in which the retailer failed to meet investors' expectations. Total revenue rose 2.6% to $28.17 billion, falling about a percentage point short of the growth rate that most of those following the stock were expecting. But net income dropped an even steeper 9% to $546 million, and even after taking some extraordinary items into account, adjusted earnings of $1.24 per share were down from year-ago levels and fell short of the $1.28 per-share consensus forecast among investors.
Looking more closely at the numbers, Costco once again saw some deterioration in its comparable-store sales. Unadjusted numbers actually looked better than they did last quarter, with a 3% gain in the U.S. offsetting weakness in Canada and other international locations and helping Costco achieve a 1% overall rise in comps. However, the impact of gasoline price deflation on Costco's domestic results was much smaller this quarter, cutting the growth by only a single percentage point. The strong dollar's impact was much larger, resulting in a 9- to 17-percentage-point swing in comps for Costco's international divisions. Overall, though, total-company adjusted comps declined another percentage point from the previous quarter to 5%.
Costco managed to improve in some areas of past concern, but others remained troublesome. Membership fee revenue climbed 3.6% to $603 million, accelerating at about double the growth rate that it posted last quarter. Yet a big 6% jump in overhead expenses sent operating income down year-over-year, and the pace of increases in Costco's merchandise costs wasn't slow enough to offset higher overhead.
What's ahead for Costco?
Another aspect of Costco's growth slowdown showed in its store counts. The warehouse retailer had 698 stores at the end of the quarter, which was up by just a single location in the U.S. over the past three months. That's consistent with the expansion plans Costco revealed last quarter, and the winter months tend to be a slow season for store openings throughout the industry.
Yet the bigger issue is whether Costco's struggles reflect weakness among more affluent U.S. consumers. Luxury retailers that cater to the wealthy have reported tough times, especially for those companies that focus on areas of the country that have gotten hit hard by the downturn in the energy industry. Costco's membership model encourages wealthier patrons, and although not all of its goods are luxury items, some of its higher-margin items cater to those with sizable disposable incomes. If those shoppers have less to spend, then it could show up in Costco's overall numbers.
Traders won't be happy with Costco's results, and even long-term investors might worry about the slow but steady deterioration in the big-box retailer's results lately. Nevertheless, Costco still holds a strong position in its retail niche, and continuing to use its inherent competitive advantages to build up its business will make sense even if Costco suffers setbacks from time to time.
