Costco Q2 2023 Earnings Call – Memberships Continue To Grow

On March 2, 2023, Costco (NYSE:COST) reported its second quarter 2023 earnings. The share price initially reacted with a fall of around 2% on the day following the announcement but has since recovered.

What did we learn from the earnings call?

Revenues and earnings – a mixed bag

COST has 838 stores worldwide, though most of its sales are delivered in the U.S. and Canada. Its membership model includes individual and business customers, allowing them to shop at its warehouses. Here are the financial highlights for the quarter:

  • Revenue rose to $55.3 billion, 7% above the comparable quarter last year
  • Earnings rose by 13% to $1.47 year-on-year
  • Earnings per share rose to $3.30, up by 13% from the $2.92 reported in Q2 2022

However, comparable sales rose less than expected, and, while analysts had expected an EPS of $3.21, revenues came in a little weaker than expected.

Online sales slump as big-ticket items fall out of favor

E-commerce sales have slumped, down 8.7% from the same quarter last year.

Richard Galanti, CFO, explained:

This weakness was driven mostly by our online mix of sales. Big-ticket discretionary departments like majors, home furnishings, small electrics, jewelry, hardware. These were down 15% in the quarter and make up 58% of our e-comm sales. These same departments, by the way, were down 11% in warehouse, but only make up 8% of warehouse ─ total warehouse on-line sales.”

Margins are stable but benefited from LIFO

Big-ticket items, of course, are generally higher-margin items. So, with the fall in online sales, it might expect gross margins to fall. However, on a reported basis, margins are up by eight basis points, to 10.72% from 10.64% a year earlier. However, core merchandise margins actually fell by six basis points.

Where Costco has benefited greatly is from LIFO (last in first out) sales of inventory. There was no LIFO charge this quarter compared to $71 million in Q2 2022. Galanti noted:

In terms of core margin on their own sales, our core-on-core margin was lower year-over-year by 26 basis points. Most major departments in general were down, with fresh foods being down a little more than others. We’re continuing to hold or drop prices where we can due to drive traffic and improve our competitive advantage. Overall, core sales benefited from sales shifting from ancillary and other businesses to core.”

Membership fees collected are up

During the quarter, Costco collected $1.027 billion in membership fees. That’s an increase of $60 million on this time last year, though this was affected by FX headwinds. Membership renewal rates are at all-time highs (92.6% in the U.S. and Canada and 90.5% worldwide), and membership growth is strong. Costco ended the quarter with:

  • 68.1 million paid household members
  • 123 million cardholders
  • 30.6 million paid executive memberships

Executive members now represent 45% of paid members and about 73% of worldwide sales.

Membership fees will rise, but when?

Costco hasn’t increased its membership fees since 2017, and Galanti was asked on the call if the company would be considering increasing these. Here’s what he had to say:

“Actually, June would be our sixth anniversary. But, and as I mentioned in the previous calls, looking at the last, I think, three, they averaged around five years and seven months, which is about now or last month…

“In our view, it’s a question of when, not if. And so, we’ll let you know. But keep in mind, that’s one way that we become even more competitive. We take those monies and directly become more ─ even more competitive.”

Can Costco continue to deliver?

While sales of bigger-ticket, discretionary items have fallen, this has been balanced by increases in sales of other items, such as fresh foods. Galanti said:

People are looking to save money. And of course, if it’s our brand, that’s great. That creates loyalty… what we look at, of course, is if our average transactions or shopping frequency is up. Our new sign-ups are continuing to be strong, up 7% in terms of new sign-ups, less than 3% new openings. So those things bode well, but people certainly are spending their dollars where they feel they should be spending them. And so, we’ll see where it goes from here.”

Costco is focused on growing its membership. It is, as Galanti put it, “a top-line company… ultimately, it’s about driving sales. And certainly, we know we’re getting the customer in. We’re getting more of them in and they’re renewing at the highest rate ever.”

A big question that needs to be answered is this: if Costco increases its membership fees, how might this impact membership?

Costco’s dividend payout ratio is a paltry 26%. There again, its forward dividend yield is only 0.75%. Trading at a PE ratio of more than 35, shares are not cheap.

There is no doubt that this is a solid company, and there is margin for it to continue to increase the dividend.  But the valuation may be stretching in this market, especially as the company was not willing to issue guidance for the future.

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