Judging by the four-star rating (out of five) that investors like you have given Costco (NASDAQ:COST) at the new super-cool CAPS community, there seem to be plenty of investors who believe the company's best days are ahead of it. And why not believe in Costco?
As Motley Fool co-founder Tom Gardner stated in a recent article, the membership warehouse operator had the hallmarks of a long-term winner: solid financials, non-dilutive board, and founding leaders with major ownership stakes. That's why Tom made it one of his Motley Fool Stock Advisor picks back in 2002, and he's been riding the selection higher ever since.
If recent trading is any indication, others have jumped on the Costco bandwagon following the release of its full-year numbers. Fourth-quarter sales of 19% surpassed analyst expectations, but what pleased Wall Street most was that Costco's bottom line fared better than expected.
Given the size and scope of Costco's fourth-quarter earnings conference call, this edition of Fool on Call will reflect the diversity and breadth of material. We'll highlight several important issues raised by management:
- Gasoline
- Executive memberships
- Expansion efforts
- HDTV situation
1. Gasoline is good for business
It makes sense that when gasoline prices are skyrocketing, stores with the cheapest gas get the most business. Costco became a favorite of road warriors hunting for a bargain on a fill-up.
CFO Richard Galanti stated that a high-priced fuel environment in the fourth quarter improved the company's same-store sales by "about 150 basis points," as a result of increased auto traffic and higher fuel prices. What goes up must come down, however; the company's September comps of 4% reflect slower traffic and lower gasoline sales stemming from the recent drop in fuel prices.
Costco's gas station is open five hours longer than the warehouse, but the company benefits substantially beyond mere gasoline transactions. During the question-and-answer portion of the call, Galanti added that the warehouses not only see greater customer frequency during times of peak gas prices, but the company also sees an increase in membership sign-ups.
2. Executive memberships, executive-level spending
Speaking of which, membership revenue growth in the period remained solid, increasing 12% to $379.5 million. Over the past year, it added 1.2 million new gold-star members, bringing the total to 17.4 million. Additionally, it added 100,000 new businesses; business memberships now total 5.2 million.
Management is pleased by the growth and performance of its $100-per-year executive membership service, which added another 250,000 members just from a quarter ago -- a 5% increase compared to Q3. This group now makes up 20% of its membership base, yet is responsible for generating "more than 50%" of the sales.
Without question, this is an important group of customers for Costco. It's a good thing, then, that its renewal rates are at an "all-time high" of roughly 86.5%.
3. Expansion increasing
One obvious way Costco can increase membership sign-up opportunities is by opening new warehouses. Management is looking to get a bit more aggressive with new store openings in 2007, as evidenced by its capex projections for the upcoming year in a range of $1.4 billion to $1.6 billion; in FY 2006, capex came in at $1.2 billion.
A 25% jump in expansion-related costs is a good indicator of the unit growth that will be coming down the pipeline. Indeed, in FY 2007, look for the company to open 35 new domestic sites, in addition to two locations in Mexico, compared to the 27 units opened in 2006. Those 37 new sites will bring the total number of Costco warehouses to 524.
Don't fret too much about cannibalization effects as Costco opens some of these units in existing markets. As Galanti said, "If we can get 15 sites opening tomorrow in Los Angeles, it would really impact our cannibalization, but we would do it in a second." Costco believes that there is plenty of business still to be made in existing markets.
4. Big TVs, not-so-big hit
Before I wrap up, I need to mention Costco's HDTV sales. Margins were negatively affected by an increased number of electronics returns in the quarter, and a large part of that was related to the company's HDTV segment.
In my analysis of recent conference calls for Best Buy (NYSE:BBY) and Circuit City (NYSE:CC), I noted that service is becoming increasingly important as electronics grow more and more complex each year. By offering installation, assistance, and other amenities, the electronics giants are aiming to reduce the amount of returns and increase sales of accessory items. Both initiatives should lead to improved profit margins for the already slim-margin HDTVs.
The issue was raised in the Q&A portion of this call, and I found Costco President Jim Sinegal's response a clear reflection of this general trend toward service. He believes the company can do more to "mitigate" some of the negative pressure it's seeing from TV returns, including further development of its "concierge program." While we shouldn't expect the service to be as full-fledged as Best Buy's or Circuit City's, the added assistance for customers should go a long way toward reducing returns and alleviating margin pressure.
Advantage: Costco
Sinegal concluded the call by acknowledging that Costco continues to "find tough markets and tough competitive situations." But the fact that it would jump at the opportunity to open 15 sites in L.A. tomorrow is evidence enough that there is plenty of business to go around, both for itself and archnemesis Wal-Mart (NYSE:WMT).
Each year, as the number of Costco stores increases, so does the company's buying power. And as buying power increases over time, profit margins should follow suit. It's a winning recipe, used time and time again by retailers.
That's not just working to Costco's advantage, but to the advantage of its shareholders as well.
More conference-call analysis:
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Costco and Best Buy are Motley Fool Stock Advisor selections, while Wal-Mart is an Inside Value pick. Whatever your investing style, the Fool has a newsletter for you.
Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool's disclosure policy is to everyone's advantage.
