Costco Wholesale (COST -0.55%) has been one of the most reliable growth engines in retail for the past several years. Its same-store sales growth has hovered around 6% or more for much of the past five years, excluding the effects of fuel. But recent results seem to have revealed some cracks in the warehouse chain's armor.
Same-store sales growth slowed to 4% in the U.S. in the most recent quarter after adjusting for the effects of gas prices, and several analysts have pointed to a slowdown caused by the strong dollar, lower gas prices, and other factors. Earnings per share fell slightly due primarily to the effects of currency exchange and other factors.
In its most important category, membership fees, Costco also appears to be weakening. Membership fees are the source of the majority of Costco's profits: its business model relies on members, who are attracted by the company's rock-bottom prices on bulk goods, while its gross margin is less than 12%. In fiscal 2015, membership fees generated more than two thirds of the company's operating income -- but growth in that category has slowed dramatically.
In the first quarter of fiscal 2016, membership fees grew just 1.9%, their slowest rate in years. Membership fee growth accelerated to 3.6% in the second quarter, but is still below its historical rate. The chart below provides further detail.
Source: SEC Filings
As you can see from the chart above, membership fee growth has been consistently falling since 2012. Most recently, that slowdown has been due to the stronger dollar. Management said fee revenue would have increased 6% in the first half of the year without the effects of currency exchange. Going back to 2012, the primary cause for the decline in fee growth seems to be the weakening Canadian dollar: the majority of Costco's international warehouses are in Canada, and the greenback has strengthened against the loonie in ever year since 2012.
While the slowing growth in membership fees may worry some investors, the underlying factor -- membership growth -- remains solid, as the chart above shows. Membership is on pace to grow at twice the rate of stores this year, and the gap between the two metrics has widened substantially since 2012. In fact, Costco is on pace this year for its fastest membership growth, net of new store openings, since 2012. Dollar figures may be weak due to currency woes, but the underlying business remains strong.
Questions about e-commerce
After posting weak results in 2015, retail giants, including Macy's and Wal-Mart, have realized that the importance of online sales as consumers seem less willing to venture out to stores. Amazon.com (AMZN -1.14%) is primed to become the second-largest American retailer by revenue next year, behind Wal-Mart, and its intense focus and sped up delivery with new programs like Prime Now virtually ensure that it will continue to grab share from brick-and-mortar retailers.
Costco is aware of the growth of e-commerce, but CEO Richard Galanti shared a telling observation on the recent earnings call. Before defending the company's broader operations, he said, "So other than everybody in the world never wanting to leave their house and only typing stuff to order and get it at the front door, other than that risk..." Amazon Prime is making it easier for customers to get toilet paper and other items that are key traffic drivers for Costco.
E-commerce sales grew 19% in the quarter, but the company has not focused on it the way other brick-and-mortar rivals have. Its business model still benefits when people visit the store, making impulse purchases in the process. Explaining why the company has resisted in-store pickup, Galanti said, "We want to do everything possible to get them in the store and not just come and pick something up," referring to the "treasure hunt" in the store as a certain percentage of the company's merchandise is always changing.
For now, Costco's business is stronger than its recent numbers would indicate, but Amazon and the wider threat from e-commerce could challenge even this model of retail consistency down the road.
