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Costco Wholesale Aims to Stay Ahead of the Pack

By Dan Caplinger – Sep 23, 2016 at 1:41PM

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The retail industry's woes have hit many companies, but Costco has beaten the odds before.


Image source: Costco.

Few retailers have managed to produce the success that Costco Wholesale (COST -0.15%) has demonstrated during its history. The member-only big-box retailer is able to offer its customers a slightly different business model that aligns their interests with Costco's, charging an up-front membership fee but then giving customers prices that other retailers typically can't match. As Costco investors prepare for Thursday's fiscal fourth-quarter financial report, they're looking to see if the warehouse retailer can avoid the downward pressure that some of its closest peers have experienced. Let's take an early look at what's been happening at Costco and whether it can build up more positive momentum going forward.

Stats on Costco

Expected EPS Growth

0%

Expected Revenue Growth

3.3%

Forward Earnings Multiple

25.6

Expected 5-Year Annualized Growth Rate

9.1%

Data source: Yahoo! Finance.

What's ahead for Costco earnings?

In recent months, investors have modestly reduced their views on Costco earnings, taking a penny off their fiscal fourth-quarter estimates and reducing full-year fiscal 2017 projections by about half a percent. The stock hasn't done much, easing downward by 2% since mid-June.

Costco's fiscal third-quarter results revealed both positives and negatives for those following the stock. Sales only managed to climb by 2.5%, with flat comparable-store sales before adjusting for gasoline price and foreign currency impacts. Even after considering the downward pressure from falling gas prices and a strong dollar, Costco's adjusted comps rose only 3%. Membership revenue rose at a faster pace, and Costco did a good job of controlling its expenses in order to support bottom-line growth. But, more generally, investors didn't see the blockbuster performance that they've come to expect from Costco over the years, and that helped keep the stock price in check.

In many investors' eyes, though, the most important thing that happened during the quarter for Costco was the transition in late June of its branded credit card from American Express (AXP 0.14%) to Citigroup (C 0.10%). The early stages of the Costco card transition did not go smoothly, with Citi receiving 1.5 million customer calls, many of which featured complaints about activation problems, cards that had never been received, or bills that they had already paid. Since then, though, Citigroup has said that new applications have flooded in. That should bode well for Costco, and investors hope that customers will quickly put the card transition behind them and keep using their memberships for the warehouse retailer.

What Costco investors need to know

Investors also need to understand that Costco has already offered reports on many of its key metrics. With monthly sales results, Costco has already said that fiscal fourth-quarter comparable store sales will be flat compared to year-ago levels, with no change in the U.S. and gains in Canada offsetting weakness in other international locations. After factoring in gasoline price deflation and currency, the quarter's comps rose 3%, with revenue climbing by about 2% to $35.7 billion. What's left to figure, though, is how much of those sales will fall through to the bottom line as earnings.

The one thing that worries some people about Costco is that its moat as a warehouse retailer might not stand up to competition from slightly different directions. So far, Costco has done a good job of keeping direct rivals like Sam's Club and BJ's Wholesale at bay, demonstrating competitive advantages and choosing its territories well. Yet e-commerce has continued to develop in recent years, offering ever-faster delivery times that can even come close to meeting customers' immediate needs. Costco has an online presence, and members can make e-commerce orders. But online purchasing just doesn't fit in with the base reason why customers originally gravitated to Costco, and it will be almost impossible to translate the warehouse experience into the e-commerce world. That could pose big problems for Costco if e-commerce giants keep improving their own customer experience.

In the Costco earnings report, take a closer look at how well membership revenue figures perform and how the company does with its margin figures. To succeed, Costco needs to work hard at finding ways to innovate and stay ahead of its bricks-and-mortar competition while also offering customers compelling reasons to stay offline and visit its physical locations.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale. The Motley Fool recommends American Express. 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.

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Stocks Mentioned

Costco Wholesale Stock Quote
Costco Wholesale
COST
$533.66 (-0.15%) $0.83
Citigroup Stock Quote
Citigroup
C
$48.29 (0.10%) $0.05
American Express Stock Quote
American Express
AXP
$154.15 (0.14%) $0.22

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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