When Costco Wholesale (COST -0.55%) reported fiscal third-quarter 2023 results, there were a couple of key weaknesses that Wall Street highlighted, notably a slowdown in same-store sales along with revenue that was below expectations.
While these are important trends to watch, from a big-picture perspective, the more important news for the retail sector as a whole is what Costco's customers were buying -- and what they weren't buying. Let's dive in.
The numbers
In fiscal Q3 2023, Costco reported sales of $53.6 billion, up from $52.6 billion in the year-ago period, which was shy of analyst expectations. So it was something of a mixed top-line result.
Image source: Getty Images.
That said, there are actually two numbers that make up this figure. Costco is a warehouse club, so customers pay a membership fee to shop at the store. Membership revenue in the quarter totaled $1.04 billion, up from $984 million in the same quarter of fiscal 2022. This is a highly reliable piece of the top line. More variable are sales related to products, which totaled $52.6 billion, up 1.9% from $51.6 billion a year ago.
For Costco, the membership fees are actually the more important figure. When you move down the earnings statement and subtract merchandise costs and selling, general, and administrative costs, you end up with a fiscal second quarter gross margin of $1.678 billion. Since most of the costs are associated with running the retail business, the vast majority of the membership fees pretty much drop to the gross margin.
Put another way, membership fees made up nearly two-thirds of gross margin in the fiscal second quarter. That's pretty typical. So while product sales are important, Costco's business is fairly resilient thanks to the annuity-like nature of its membership fees.
But there's still a great deal of value in watching Costco's product sales. It is one of the largest retailers in the world, and it tends to have a lot of customers who are relatively wealthy. What its customers are buying and what they aren't buying can be very telling.
The trends are not your friend
While Costco doesn't actually break out category numbers dollar for dollar, management does provide broader breakdowns. In fiscal Q3, Costco was clear that its customers were buying basic necessities like clothing and food. What they weren't buying were big-ticket items that were more discretionary in nature.
During Costco's fiscal Q3 2023 earnings conference call, CFO Richard Galanti summed it up like this: "Our average daily transaction or ticket was down 4.2% worldwide and down 3.5% in the U.S., impacted, in large part, from weakness in bigger-ticket nonfood discretionary items."
There's a lot in that statement when you pull back to the broader picture. In general, wealthy consumers are spending less and focusing more on necessity items. This could be why Walmart, which caters to less well-off customers, saw revenue grow 7.6% in its latest quarter. By contrast, Target (TGT 1.28%), saw sales fall short of analyst expectations. Like Costco, Target tends to cater to wealthier customers. Again, people are likely trading down to lower-cost providers.
So the big takeaway from Costco's results, supported by the results of Walmart and Target, is that people -- even wealthy people -- are increasingly looking to save money. This is an issue the entire retail sector will likely have to deal with -- though some areas might end up harder hit than others. For example, low-price stores and discounters will probably fare better than, say, full-price retailers and luxury stores.
Tread with caution
Given the uncertainty today, with inflation raging and concerns about a potential recession, it is understandable that people are increasingly cautious. This is highly likely to remain an issue in the quarters ahead for all retailers.
If you are looking at the retail sector today, make sure you keep in mind the warning in the sales trends at Costco (which is somewhat insulated by its membership model), as well as Walmart and Target, before you jump on a stock that looks cheap. It might just be cheap for a reason.
