Costco (COST 2.03%) is having an indifferent year so far with shares down almost 4%. The company's second-quarter results weren't up to the mark as it focused on discounts to attract shoppers during the holiday season, and this has weighed on its share price this year.
However, investors shouldn't worry too much because the company looks well-positioned for the long run. It is doing better than peers such as Target (TGT +1.20%) and Wal-Mart's (WMT 0.52%) Sam's Club. Its warehouse-membership model seems robust, and a look at the different strategies that it is undertaking will tell us why Costco should get better going forward.
Not too bad
Costco's overall sales for the entire second-quarter were up, but it saw a negative impact on its gross margin. Its performance in the four-week period between Thanksgiving and Christmas took a hit, and sales for the quarter were affected by gas price deflation and weakening of foreign currencies relative to the dollar. Weather also played an important role in Costco's weakness. However, the retailer showed signs of improvement in the second half of the quarter, with an increase in the earnings in the final eight weeks.
Costco is focusing on expansions. It had opened 13 new locations in the first quarter, and opened three more in the second quarter, of which two are in the U.S. and one in Canada. Going forward, the company expects to open new stores at 14 different locations by the end of this fiscal. Its expansion plans include many international locations such as Japan, Korea, Canada, the U.K., Australia and Spain. As a result of planned expansions, Costco has increased its capital expenditure forecast. Management expects capital expenditure to be around $2.3 billion this fiscal, up from the prior forecast of $2.1 billion.
Memberships and e-commerce should drive growth
Costco is also seeing an improvement in its membership fees, which were up 4% as compared to last year. According to management, Costco's renewal rates are at record levels. Its new membership sign-ups increased 13% on account of recent international openings in Japan and Australia. This is a key indicator of Costco's performance going forward. Higher fees point toward an increase in traffic in its warehouses as customers make use of their Costco membership to purchase products.
Costco has expanded its e-commerce operations in various countries. It already had e-commerce operations in the U.S., Canada, and the U.K., and now it has expanded into Mexico as well. The company has made considerable changes to its website in the past one and half years. It has added new mobile apps and combined e-commerce initiatives with its in-store efforts. Recently, it added apparel, health, and beauty aids to its e-commerce platform.
Better than peers
Costco has worked toward lowering its already-discounted prices in the last year to attract more customers to its annual membership plan, according to Bloomberg. This move is already providing strong results as memberships have increased, and going forward lower discounts should lead to better margins.
In addition, Costco seems to be performing better than Wal-Mart's Sam's Club. According to Wal-Mart, same-store sales, or comps, at Sam's Club were down 0.5% year over year in the recently concluded first quarter. In comparison, Costco's comps were up 3% in the previous quarter. Sam's Club is suffering due to a variety of reasons -- targeting customers who depend more on food assistance, the encroachment of e-commerce players, and Wal-Mart's own product offerings. In comparison, Costco focuses on a relatively well-off customer base.
Comparatively, Costco seems to have a loyal customer base, as 75% of its operating profit comes from membership fees. Costco offers products under signature brands such as Kirkland, providing customers with quality products at an affordable price. This is the reason why Costco has performed better than the likes of both Sam's Club and Target.
Costco's competitive pricing is proving to be a headache for Target, which saw its first-quarter profit drop 16%. Target's foray into Canada has been unsuccessful as the company is unable to provide the required inventory at the right prices. Target opened 124 stores in Canada last year, but it has scaled back its expansion in the country. The retailer will open just 9 stores in Canada this fiscal year. According to USA Today, "Analysts say the store's [Target] prices aren't competitive with the likes of Canadian operations of Walmart and Costco, and that merchandise is consistently out of stock."
Takeaway
Costco seems to be doing better than its peers. Although its second quarter was weak, investors should look at the long-term. Costco is seeing good growth in memberships and is expanding across the globe. Also, the stock offers a 1.20% dividend yield. So, investors should consider taking a closer look at Costco and think of buying more shares on the pullback.
