Costco Just Gave Investors Almost Everything They Were Looking For

Many investors had been looking for the streak of impressive results to continue at Costco Wholesale Corporation (COST -0.24%), and by most accounts it delivered when it reported third-quarter results on May 31. The top- and bottom-line results exceeded expectations, and same-store sales increased at an impressive clip.

While the stock initially fell following the earnings release, it regained much of the losses once investors had time to digest the numbers and decide the company's margin declines weren't as bad as initially feared.

Image source: Costco.

Costco: The raw numbers

Data source: Costco third-quarter 2018 financial release.

What happened at Costco this quarter?

Costco reported revenue of $32.36 billion, up 12% year over year, and exceeding analysts' consensus estimates of $31.84 billion. Operating income of $1.07 billion grew 10% compared to the prior-year quarter. Net income of $750 million was up 7.1% compared to the year-ago period, generating diluted earnings per share of $1.70 -- an increase of 7.5% year over year, and surpassing analysts' expectations of $1.69.

The bottom-line results were even better than they appeared, as the third quarter of last year was positively impacted by a tax benefit of $82 million, or $0.19 per share, in connection with the special cash dividend. Adjusting for that one-time benefit resulted in earnings per share that increased 22% year over year.

Membership fees continued their upward trajectory to $737 million, up 14.4% compared to the prior-year quarter. Positive foreign currency effects added about $9 million to the results, so adjusting for those resulted in an increase of about 13%. The company said it will continue to see the benefit of the membership increase that took effect on renewals occurring after June of last year. The results will peak in the fourth quarter, but still provide year-over-year improvements going into next year.

Comparable sales for stores open more than a year posted impressive gains, up 10.2% overall, and up 7% excluding fluctuations related to gas inflation and foreign currency exchange rates. Same-store sales in the domestic market increased 9.7% and 7.7%, respectively; Canada rose 11.3% and 4.8%, and other international markets grew 11.8% and 5.8%.

Traffic also increased during the quarter, up 5.1% year over year, both worldwide and in the U.S. The average ticket increased 4.9%, although excluding fuel and exchange rates, it grew a more modest 1.7%.

Costco's e-commerce results grew at a fast clip, with comparable online sales up 36.8% year over year, and up 35.5% excluding the impact of foreign currency.

Customers continued to renew at a stellar rate in North America, 90.1%; worldwide renewals came in at an impressive, but slightly lower, 87.5%. This led to 93 million total cardholders.

With all the good news, investors seemed to focus on the one challenge Costco faced during the quarter. The company's gross margin declined by 46 basis points to 11.05%, and missed analysts' forecasts for 11.4%. This line item was also skewed by changes in the cost of fuel, and adjusting for those would have resulted in a smaller 28-basis-point decline.

On the conference call with analysts, CFO Richard Galanti reminded investors of Costco's attitude on costs: "You've all heard over the years: When costs are going up, we want to be the last to go up. And when prices are going down, when costs are going down, we want to be the first to go down."

Looking ahead

Costco doesn't provide guidance for the coming quarters, because there are too many moving parts to its business. However, the company did provide insight into how it would be spending some of the windfall it should receive this year as the result of last year's tax reform.

While the company doesn't expect any major changes to its capital allocation plans, Galanti revealed how Costco would be putting some of its income tax savings to work: The company is increasing the starting wages for entry-level employees by $1 to $14 per hour, which will impact its results by between $110 million and $120 million, before tax.

That aside, this quarter seemed very much "business as usual" for the warehouse retailer -- which is great news for long-term investors.