Despite Earnings Miss, Costco Stock Is Still a Buy
Costco Wholesale released earnings last week, and while sales and earnings grew at the big-box retailer, for the first time in two years, the growth was more modest than analyst expectations. The miss was due to costs rising faster than anticipated and slower revenue growth. That concerned some investors, with the stock selling off right after quarterly earnings became public. But for a retailer like Costco, with a unique subscriber-based business model, gross revenue is not the most important metric to consider. When looking at Costco's results from a lens that considers the stock's most essential profit drivers, the quarterly earnings report confirms that Costco stock is still a buy.
Costco's sales rose by just 0.8% to $32.5 billion, slower than the company has seen in any quarter since 2009. However, it shouldn't be judged by its raw revenue figures. Unlike nearly all retailers, Costco doesn't make much money at all from selling goods. It aims to keep its gross margin low, around 11%, selling a product for about what it costs to buy the product from the supplier and keep the rent paid, the lights on, and the staff happy at its warehouse locations. Therefore, higher sales don't directly translate to higher profits.
Costco makes its profits not by selling goods but by selling memberships -- annual fees that customers must pay in order to shop at the stores. Overall sales figures therefore take a backseat in determining Costco's financial fate. Because Costco stockholders make their profits from members, they need to be looking at membership fees, membership renewal rates, and new-member signups. All three metrics showed impressive progressive in Costco's most recent quarter.
Fees rose 3% in the most recent quarter -- more like 6%, accounting for foreign currency fluctuations. In most businesses, higher fees lead to fewer customers, but that's not Costco's experience. Membership renewals remained strong in the quarter, declining negligibly from 86.4% to 86.3%. That slight decline is primarily due to new stores opening outside the U.S. and Canada. Costco has seen that new stores in international markets typically recruit far more new members than the North American average, albeit at the cost of lower initial renewal rates. Renewal rates in Costco's core U.S. and Canada business markets actually increased, from 93.9% to 94%. According with lower renewal rates from international stores, new-member signups rose 9% in the quarter, owing to very strong new-store openings internationally, particularly in Japan.
All this led to a slight earnings increase of just $0.01 per share, up to $1.40 from 2012, though the comparable quarter in 2012 had an extra week of sales and profit. The larger takeaway is that Costco's international stores, young as they are, are proving their worth in attracting and keeping new members. While international renewal rates are still much lower than North American renewal rates, that's balanced in part by the larger number of members new international stores attract. Costco takes lower East Asian renewal rates to be a sign that existing warehouse locations are simply too inconvenient for some shoppers, indicating that there's plenty of room to grow even in existing international Costco markets. With more than 80% of Costco locations still in the U.S. and Canada, any sign that Costco is entering international markets with even a fraction of the success it has seen so far indicates that it still has a long and profitable growth runway ahead.
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The article Despite Earnings Miss, Costco Stock Is Still a Buy originally appeared on Fool.com.Fool contributor Daniel Ferry owns shares of Costco Wholesale. The Motley Fool recommends and owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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