Costco Wholesale's (COST, Financial) stock moved sharply lower, losing more than 4% after the company missed earnings expectations by a wide margin. Revenue and comparable store sales also came in below expectations.
Comparable store sales improved 3% during the quarter, helping the company’s net sales increase 6% to $29.13 billion from $27.57 billion last year. Despite the solid increase in net sales, Costco’s net income for the quarter declined 6% from $546 million last year to $515 million.
Costco increased its membership fees back in 2011. It recently announced it will be increasing its primary membership fees to $60, a $5 increase; executive members will see their fees go up from $110 to $120. Along with the membership fee increase, Costco is revising the reward cap upward for executive members from $750 to $1,000. So by paying $10 extra, executive members get $250 added to their annual rewards. The new plan goes into effect on June 1.
The current reward plan
As the fee increase brings more value to the customer, Costco hopes drop-offs will be negligible. Increasing membership fees in this way will obviously have a positive effect on Costco’s operating margin, which has been squeezed.
According to a Tech Times article,  the United Bank of Switzerland forecasted consumers will not negatively react to a hike in membership fees. Since Visa (V, Financial) gives Costco consumers 2% cash back versus 1% on the American Express (AXP, Financial) cards, members will only need to spend $500 in a year to break even on the $5 increase.
In addition, JPMorgan predicts this hike will give Costco a 3% to 5% increase in annual earnings for the next two years.
Costco blamed lower gas margins for the drop in overall margins. During the second-quarter earnings call, Chief Financial Officer Richard Galanti said:
“Overall, our margins, except the Citi Visa Credit Card benefit, were most negatively impacted by lower gas margins. Somewhat negatively impacted by five basis points from LIFO year-over-year, 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 seven basis points.“
Costco opened 29 new stores in 2016 and is expecting the same this year as well. With renewal rates for the second quarter coming in at 90.2% in the United States and Canada, a drop of one-tenth of a percentage point from 90.3%, it is clear Costco is still holding onto its members.
Considering the amount of competition in the market, the high renewal rate indicates the perceived value of Costco’s membership program. As long as this number remains high, Costco will be able to weather most of the storms it faces.
Only a handful of big-box stores have been able to post positive comparable store sales in the past six months, which did not happen by chance. There is strong value differentiation provided by these companies, and that is the reason why they are seeing more customers walking into their stores.
Target (TGT, Financial) and Kroger (KR, Financial) have seen their margins and comps shrink. These are extremely difficult times for retailers, but despite the bad bottom-line numbers, Costco remains one of the best retailers around.
Disclosure: I have no positions in the stock mentioned and have no intention of initiating a position in the next 72 hours.
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