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The Science of Hitting
The Science of Hitting
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Costco: Maintaining Its Dominance

A look at the company's financial results for the 3rd quarter of fiscal 2019

June 05, 2019 | About:

Costco (NASDAQ:COST) recently reported financial results for the third quarter of fiscal 2019.

Net sales for the period increased 7% to $34 billion. For the first nine months of the fiscal year, revenues (inclusive of membership fees) increased 8% to $105 billion. Same store sales (comps) increased by nearly 6% in the third quarter, due to a combination of both traffic and ticket growth. Comps have increased by a mid-single digit percentage year to date, helped by more than 20% growth in the company’s e-commerce business (despite this outsized growth, e-commerce still accounts for less than 5% of Costco’s revenues). It’s worth noting that Costco continues to invest to support growth in the e-commerce business, including regional grocery distribution centers, in-store pickup lockers to support buy online and pick up in store, and new geographies (with Japan and Australia both launching later this year).

Costco has delivered outsized same-store sales growth for some time, even relative to peers like Dollar Tree (NASDAQ:DLTR), Dollar General (NYSE:DG) and Walmart (NYSE:WMT), which have put up solid numbers as well. As shown below, Costco’s two-year stacked comp (which smooths the noise in a given quarter from one-time events like weather) has consistently exceeded 10% of late:

(Note: I adjusted fiscal periods as needed to align with the calendar quarters)

Member households and total cardholders both increased by roughly 4% (to 53.1 million and 97.2 million, respectively), with renewal rates holding around 90%. Costco ended the quarter with 773 warehouses around the world (up 3% from the year-ago period), with comparable percentage growth for the U.S. and international markets. While low-single digit unit growth is disappointing to some, it shouldn’t come as a surprise:

The most notable current example of slow but steady expansion from Costco is its move into China, which CFO Richard Galanti discussed on the call:

“At this juncture we have two locations [planned], one we're opening this summer, and another, if all things go well, almost two years from now … That's not different from what we've done in other countries. In Australia we opened three over the first four years. In Japan we opened six over five years. And in Spain we open two over four years. So that's not inconsistent … What we said is if it’s very successful, we're perfectly happy to have a couple of units over the first two or three years and four or five total units after four or five years … and we'll go from there.”

That pace does little to help drive revenue and earnings growth in the short term. With that said, it’s an approach Costco has employed repeatedly with success (as Galanti noted earlier on the call, “We’ve been fortunate that our concept works in virtually every other country we’ve gone to.”). And as you can see from the long-term performance of the stock and the business, slow and steady unit growth is a strategy that has worked for investors as well.

Net income in the quarter was $906 million, with diluted earnings per share climbing 11% to $1.9 per share (that adjustment excludes the benefit of a non-recurring tax item). Through the first nine months of the fiscal year, adjusted earnings per share has climbed by a high teens percentage to $5.6 per share (with help from a lower effective tax rate).

Costco continues to have a strong balance sheet, with $8.1 billion in cash and short-term investments against $5.6 billion in total debt. The company is much more conservatively financed than its retail peers.

On capital returns, the board of directors recently reauthorized a $4 billion common stock repurchase plan that expires in four years. To date in fiscal 2019, the company has spent $195 million to repurchase 193,000 shares at an average cost of $216 per share.

In addition, the board increased the dividend 14% to an annual payout of $2.60 per share (with the payout ratio at 30-35%). Since the dividend was initiated in 2004, it has increased at a compounded annual growth rate (CAGR) of 13%. In addition, the company has paid a handful of special dividends in the past ($7 per share in 2012, $5 per share in 2015, and $7 per share in 2017). Considering the strength of the balance sheet, another one may be around the corner.

Mr. Market has not been oblivious to Costco’s strong results, with the stock trading at roughly 30 times forward earnings. As that implies, investors need to believe it will continue to execute for a long time to justify that multiple. I don’t own Costco (actions speak louder than words), but I have a high degree of confidence it can continue to deliver. If the stock price retreated to a level that I found palatable, I would happily invest alongside the management team for the long term.

Disclosure: None.

Read more here:

Dollar General: Another Step Forward

A Look at Dollar Tree's Start to Fiscal 2019

An Update on Markel After a Tough Year

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About the author:

The Science of Hitting
I'm a value investor with a long-term focus. My goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio - a handful of equities account for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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Comments

batbeer2
Batbeer2 premium member - 1 month ago

Hi SoH,

With regards to Costco's expansion into China you say:

>> That pace does little to help drive revenue and earnings growth in the short term.

Yes, but Costco's earnings are tied to the number of members and not the number of shops (or same-store sales etc. etc.). The shops are in fact an overhead cost. It's the membership fees that provide the income. Setting the right pace is important though. As discussed here, Costco's costs are lower (in part) because the company carefully cultivates a specific and fairly uniform cabal of members.

Also, if I remember correctly, Costco is partnering with Alibaba in China. How might that affect the growth rate of membership? What's the price of membership?

I plan to look into these things myself but I'd appreciate your thoughts/guestimates.

The Science of Hitting
The Science of Hitting - 3 weeks ago    Report SPAM

Batbeer - I hear you on the members (membership income), but that's a chicken and an egg situation, right? Need warehouses and engaged members (SSS growth) to support new member growth and high retention rates. But I agree :) And I'll do some more background work on Costco in China. Maybe worth another article. Thanks for the comment!

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