Costco: Solid Q3 Earnings In Difficult Trading Environment (NASDAQ:COST)

Costco Q3 Numbers

Costco Wholesale Corporation (NASDAQ:COST) is just off the back of announcing its third-quarter earnings numbers where net sales grew by over 16% and net profit (which included a one-off $77 million charge related to the updated employee agreement) increased by approximately 10.7%. The Q3 bottom line number ($1.35 million) is not a bad comparison because there was a similar Covid-19-related charge in the same quarter 12 months prior for the sum of $57 million. Although growth was expected in the third quarter, it was refreshing to see both revenues ($52.6 billion) and earnings ($3.04 per share) beat consensus for the 12 weeks up to the 8th of May this year.

Direction Still Undecided In The Short-Term

Suffice it to say, it will be interesting to see the market’s reaction to these numbers over the forthcoming sessions. As we can see below, the 100-week moving average provided solid support for shares last week as it has done for many years now. Nevertheless, if the market believes Costco is not experiencing enough growth at present for the valuation it trades at, and as a result, shares break below the $420 level and head towards the 200-week moving average, this would present a rare buying opportunity in this stock.

Declining earnings revisions have started to creep into consensus numbers and are accelerating slightly, with the expected $4.14 EPS number for Q4 down 1.6% over the past 30 days alone. Therefore, investors should be prepared for volatility over the near term and treat Costco more as a hold. However, long term, Costco is going higher. In fact, here are some reasons why the present trading environment (surrounding supply chain headwinds & high inflation) may in fact serve the company instead of hindering it.

Absence Of Membership Fee Increase

Bottom-line growth may be tapering off a tad as alluded to above, but this is not stopping renewal rates from making all-time highs. In the U.S. & Canadian markets, the renewal rate rose above 92% and the worldwide rate has hit a record 90%. Now, given Costco’s business model (with how it collects its fees on the front-end) and how growing auto-renewals and executive members have been acting as strong tailwinds for renewal rates, management could simply increase the membership fee. This, in turn, would immediately impact the financials. An increase is certainly due, as the company has not increased the fee since June 2017.

However, despite the 6-year gap as well as the inflation, Costco is experiencing in wages, raw materials, etc., management has refrained from doing so. Therefore, if we are to believe that as long as inflation remains high, management will not move on the membership fee, the company simply has to gain market share going forward. Why? Because the higher inflation stays, the more price-sensitive customers will become. Therefore, the longer Costco’s entry fee does not rise, the more customers will be inclined to shop at its big box stores.

Business Model Benefit

Bob Nelson (Senior Vice President) spoke of this on the recent Q3 earnings conference call, where he kept on returning to the value proposition which is the clear priority for Costco in the present environment. Again, due to the strong cash-flow nature of Costco’s business model, Nelson stated that the company can be selective on where to hike prices and where not to. Whereas most retailers will have to implement price increases across the board if indeed inflation persists, Costco (having market-share gains in mind) may (like the membership fee) stall increases on selective products if the value proposition is still there.

This is very smart marketing in a price-sensitive environment and comes back to the low number of stock-keeping units Costco manages compared to other retailers. Management can negotiate bulk pricing based on stronger volumes due to cheaper pricing than the market, for example. Nelson also stated that other suppliers remain on hand if indeed supply-chain issues were to escalate in upcoming quarters. Here we see the advantage of being a huge customer to its suppliers. Product will get delivered – period.

Conclusion

To sum up, although Costco once more beat earnings estimates in the third quarter, the decision to keep the hot dog/soda at $1.50 would have definitely caught more media attention. Furthermore, the decision to abstain from increasing the membership fee at present is also a trump card from management and should increase those renewal rates even higher over time. In the short-term, since shares remain well below their 200-day moving average of approximately $508 per share, we are undecided on near-term direction. This makes Costco a hold for us at present. We look forward to continued coverage.