I have always been highly optimistic about the prospects of Costco (COST, Financial) as the retailer has been successful in beating the headwinds facing the brick-and-mortar retailers. The weak economy and increasing presence of e-commerce players has hampered the margins of brick-and-mortar stores but Costco has defied these circumstantial factors with a robust membership model and extreme focus on quality and cost of products sold. The evidence of these claims can be easily found in the solid fourth quarter results reported by the company.
Strong earnings
Costco has always had remarkable results by focusing on its revenue, the main reason being that it operates at low margins, and turning stock to cash as fast as possible is the only source to generate better profits. The company's top line surged 9.3% in its fourth quarter to $35.52 billion compared to $32.49 billion in the prior year period. For the full year, it reported revenue of $112.6 billion, narrowly beating the consensus estimate of $112.5 billion, representing 7% growth for the fiscal year. Comp sales increased 6% for the quarter and 4% for the year, considering currency impacts and gasoline price decreases, which reduced the comps by one to two percentage points.
The big box warehouse retailer surprised everyone with its impressive net income for the quarter. Compared to last year, net income increased 13%, pushing earnings per share to $1.58, edging out analysts' estimates by $0.06 per share. For the fiscal year, the company earned $2.06 billion, 1% higher than its last year's earnings before adjusting for a one-time tax benefit. Most importantly membership fees revenue climbed 7% to $768 million for the quarter and $2.43 billion for the full fiscal year. Membership fee hardly accounts for almost 70% of its operating profits. Therefore, this surge in membership fee revenue is a boon to the company. Costco continues to enjoy string renewal rates, rounding up to 91% in the U.S. and Canada, and little over 87% worldwide. New member signups in Q4 overall number a little over 2 million. This was about a 7% increase year over year. This was helped, of course, by strong new signups and a few overseas openings in Australia, Korea and Spain over the past year.
Attracting youngsters
Based on the current results, it is quite clear that the membership model is at the heart of Costco’s profitability and hence, the company constantly puts in credible efforts to provide fuel to this area. However, Costco has a potential weakness when it comes to customers and that is its aging customer base. A good chunk of Costco’s customer base is the baby boomers, and the company has traditionally located its stores near wealthy suburban communities in the U.S. and Canada. However, the company is now putting efforts into bringing the young customers to its stores and, somehow, appealing to them. The most recent tactic was a LivingSocial deal. For $55 (the regular cost of a membership), people who signed up also got a $20 cash card, a rotisserie chicken, an apple pie and a package of Kirkland Signature toilet paper, plus some other offers. In other words, the LivingSocial deal provided a whole lot of extra value, making the effective cost of the membership close to $0.
Taking on e-commerce
At the onset of this article, I mentioned the advent of e-commerce and how it has encroached the profits of traditional retail chains. As such, big box retailers like Walmart (WMT, Financial) and Target (TGT, Financial) have already entered the web space in collaboration with the tech companies to get a slice of this pie. Well, Costco is also not lagging in this race as this warehouse-club chain is also moving largely to e-commerce. Last year, Costco's e-commerce sales totaled just under $3 billion: less than 3% of total sales thereby representing a reasonably big growth opportunity for the company. Costco is trying out a few strategies to drive e-commerce growth. One tool is simply expanding to new countries. Costco only operates e-commerce sites in the U.S., U.K., Canada and Mexico today. However, it has warehouses in several other countries, including Japan, South Korea and Australia. Costco plans to add 1-2 countries to its e-commerce operations in the upcoming year.
Again, to give you a big example on this, Costco has already made its way into one of the largest retail markets in the world i.e China, even without opening a single store. The company has opened a store on T-Mall, an online marketplace Chinese e-commerce giant Alibaba (BABA, Financial) operates alongside the Taobao bazaar. The store, where consumers can buy Costco baby care goods, beauty items, dietary supplements as well as household products, will mail purchases directly from the U.S. to consumer doorsteps, a process that takes five to 20 days, according to the store website. Though the competitive pressure is quite high in the market yet, the fact that Costco has entered the market is a big win.
Takeaway
Costco's latest earnings demonstrate that the company is a solid long-term investment opportunity due to its steady high single-digit growth rate and consistent profitability. At a time of weakening economic growth and shrinking margins, Costco has proved its tremendous ability and hence, it is the best pick in retail sector.
