Costco’s loyal customer base, improving e-commerce business and growing membership are a competitive moat, analysts say
Costco Wholesale Corp. shares fell Friday and were the second-biggest S&P 500 decliner, after the company reported weaker-than-expected sales for its fiscal first quarter.
The stock COST, -8.59% was last down 8.1%, putting it on track for its worst one-day percentage decline since October 2008, according to FactSet data.
The Issaquah, Wash.-based company said late Thursday it had net income of $767 million, or $1.73 a share, in the quarter to Nov. 25, up from $640 million, or $1.45 a share, in the year-earlier quarter. Sales rose 10.3% to $34.31 billion. The FactSet-compiled broker consensus was for EPS of $1.65 and revenue of $35.078 billion.
On the company’s earnings call with analysts, Chief Financial Officer Richard Galanti said membership fees rose 9.5%, or by $66 million, to $758 million, boosted by a membership fee increase take in June 2017, according to a FactSet transcript. It typically takes about 23 months for a price hike to show up in the income statement, he told analysts. Renewal rates rose to 90.5% from 90.4% at the end of the fourth quarter.
But gross margins shrank by about 50 basis points to 10.75%, while core merchandise gross margins declined 6 basis points, more than the 2 basis point decline posted in the fourth quarter.
Analysts weighing in on the numbers were unfazed. At Stifel, analysts led by Mark Astrachan said their long-term view of the stock is unchanged, although they lowered their fiscal 2019 and 2020 estimates by 2% to 3%, while maintaining a buy rating and $245 price target.
The estimate cut was mostly due to competition in fresh food, where Galanti said sales were solid, but conceded that the company had sacrificed margin to better compete with rivals.
“The company said fulfillment costs are also pressuring core gross margin, and we believe price investments continue to be a headwind,” Astrachan wrote in a note.
Going forward, “we anticipate the company will continue to invest in price and digital/e-commerce to further reinforce its value proposition, which we view as key to sustaining favorable comp and traffic trends and continued outperformance relative to peers,” said the note.
BMO Capital Markets analyst Kelly Bania said Costco is being disciplined on cost and succeeding in driving customer loyalty.
The numbers “were supported by rising renewal rates, increasing executive membership penetration, solid ticket & traffic growth as well as still solid core gross margins in light of a competitive fresh food backdrop,” Bania wrote in a note.
Key membership metrics were strong and gas margins increased. The analyst is sticking with an outperform rating on the stock, based on expectations that e-commerce is still in the early stages and could support a strong outlook and higher valuation as the company bolsters its competitive moat with a deeper digital relationship with customers.
BMO is sticking with its stock price target of $258.
Raymond James also reiterated an outperform rating and a $252 stock price target.
“Costco’s ongoing sales momentum throughout calendar year 2018 (against more challenging prior year comparisons) illustrates that its business model remains well intact and consumers continue to find value in its product assortment and membership benefits,” analysts Budd Bugatch and Bobby Griffin wrote in a note.
Raymond James is another believer in Costco’s e-commerce capabilities which are improving without hurting foot traffic to its stores.
“We continue to see a multiyear runway for Costco to gain further market share and members through U.S. and international club openings in FY19 & beyond,” the analysts wrote in a note. “Accordingly, we continue to see a favorable risk/reward in owning COST.”
Costco shares have gained 13% in 2018, while the S&P 500 SPX, -1.91% has fallen 1.6% and the Dow Jones Industrial Average DJIA, -2.02% has fallen 1.4%.
