Costco (COST) is trading lower today after reporting disappointing 2Q17 (Feb) earnings results last night. You are likely familiar with Costco but you may not know some of the finer points. In terms of store count, Costco currently operates 728 warehouses, including 508 in the US and Puerto Rico, 94 in Canada, 37 in Mexico, 28 in the UK, 25 in Japan, 13 in Korea, 13 in Taiwan, eight in Australia and two in Spain.
Its membership warehouses are based on the concept that offering low prices on a limited selection of nationally branded and select private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. As a result of its volume purchasing and its no-frills, self-service warehouse format, Costco is able to operate profitably at significantly lower gross margins than traditional supermarkets and supercenters. Also, Costco buys the majority of its merchandise directly from manufacturers, eliminating many of the costs associated with traditional multiple-step distribution channels. It also makes money by charging annual membership fees.
Turning to the FebQ earnings results, EPS fell 6% YoY to $1.17 from $1.24 last year while revenue rose 5.7% YoY to $29.77 bln. EPS was a good amount below market expectations while revenue was basically in-line. Operating margin declined slightly to 2.8% from 3.0% in the year ago period. Membership fee revenue rose 5% YoY to $636 mln.
In terms of FebQ same store comps, they came in at +3% (+3% in US, +8% in Canada, -2% in Other International). Comps, excluding the impacts from changes in gasoline prices and foreign exchange, came in at +3% (+3% in US, +2% in Canada, +3% in Other International). So the impact of gasoline and FX on comps was pretty minimal in FebQ unlike some other quarters where they have had a big impact.
The other big news in addition to earnings is that Costco announced it will raise its annual membership fees on June 1 by $5 for US and Canada Goldstar (individual), Business, and Business add-on members ("Primary" Members). With this increase, Goldstar, Business and Business add-ons will pay an annual fee of $60, up from $55. Annual fees for Executive Memberships in the US and Canada will increase from $110 to $120 and the maximum annual 2% reward associated with the Executive Membership will increase from $750 to $1,000. The fee increases will impact around 35 mln members, roughly half of them Executive Members.
On the call last night, the company said that the Midwest, Texas and Northwest regions were the strongest, with California not far behind. Internationally, in local currencies, better performing countries were Mexico, UK and Korea. In terms of merchandise category, within food and sundries, overall sales were flattish year over year. Liquor or spirits and foods were the leaders. Tobacco continues to be a negative and actually in the high teens.
For hardlines, overall, in the low to mid-single digits. The strongest department results were tires, hardware and seasonal, with consumer electronics down in the low single digits. Softlines were also up in the low to mid-single-digit range, with apparel and home furnishings showing the strongest results. In fresh foods, comp sales were also in the low to mid-single digits.
Management noted that margins, ex the Citi Visa credit card benefit, were most negatively impacted by lower gas margins, somewhat negatively impacted by 5 basis points from LIFO, with slightly lower year-over-year sales penetration in the quarter also hurting it a little bit, even though core margins on the core sales were up 7 basis points.
Of note, Costco made a big change in June 2016 when it stopped accepting American Express at all US and Puerto Rico locations and began accepting all Visa cards including of course the new Citi Visa Anywhere card, which gives special cash back rates for Costco purchases.
In sum, with the stock lower, it seems investors are a bit disappointed with these earnings results. Costco seemed to be less immune to the overall retail weakness (Target sold off this week) but the FebQ results came up short. Hopefully, it's just a near term blip, but the company had beaten EPS expectations for three quarters in a row before this pretty sizeable EPS miss this quarter.