Costco Shares Have Been Poorly Received By Investors

Costco (COST) reported 4th quarter results that showed a surprising beat on the bottom line.

Initially, the stock reacted with a nearly 5% surge in the share price before cutting those gains in half.  For the quarter, earnings came in at $1.77 a share, up 2% or $0.04 over last year’s fourth quarter earnings of $1.73 a share. Lower gasoline and grocery prices continued to weigh on the retailer’s results, but even so, the retailer outperformed during the quarter.

Sales for the fourth quarter were $35.7 billion. Total reported sales were up 2% for the period on a YOY basis. Fourth quarter 16-week reported comparable sales figures were flat year-over-year. Comparable sales were negatively impacted by gas price deflation. That was a little over 200 basis points of impact to the company and by weaker foreign currencies relative to the U.S. dollar, the latter about 1 percentage point of impact to sales. Excluding deflation, the flat U.S. comp sales figure for the fourth quarter would have been plus 2%. The reported Canadian comp figure of plus 2% would have been plus 5% ex-gas and FX and the reported minus 2% other international comp figure, ex these two factors, would have been plus 1%. Total comps were reported as zero for the quarter and again, excluding gas and FX, would have been plus 3%. Tobacco was the big negative, as that was down 21% year-over-year and as Costco continues to see lower sales in that category. If I look at the food and sundries category, that again on a comp basis was slightly negative year-over-year for the quarter. Ex the tobacco department, it was plus 3. And you can see – continue to see tobacco impacting us into the early spring.

Costco opened 10 new locations and also completed 1 relocation during the Q4 period. And for the fiscal year, the retailer opened 29 net new locations. Of the 29 locations, 21 were in the U.S., 2 are in Canada, 2 are in Japan, and 1 each were in UK, Taiwan, Australia and Spain.  For fiscal 2017, Costco plans to open a net of 31 new stores. Seventeen of these new locations will be in the U.S., 7 in Canada and 1 each in Taiwan, Korea, Japan, Australia, Mexico, France, the first in France and also a unit in Iceland.

Reported membership revenues were $832 million, up 9 basis points and $47 million or up 6% in dollars versus last year’s fourth quarter. In terms of number of members at fourth quarter and year end, at year end, Costco had 36.8 million Gold Star members, up from 36.2 million 16 weeks earlier at the end of the third quarter. Primary Business ticked up to 7.3 million from 7.2 million. 86.7 million at year end, up from 85.5 million just 16 weeks earlier. Executive Members, we have of the 47.6 million member households, we have 17.4 million. That was an increase of 370,000 during the 16-week fourth quarter

Regarding membership fees, effective the beginning of September, Costco increased membership fee – annual membership fees by about 10% in three Asia locations Taiwan, Korea, and Japan, as well as in Mexico and the UK.

In terms of gross margin, Costco’s reported gross margin was higher year-over-year in the fourth quarter by 28 basis points from, up from 11.14% a year ago to 11.42%. This marked the 3rd straight quarter in which Costco expanded gross margins.

In terms of average inventory per warehouse, last year fourth quarter end, it stood at exactly $13 million per warehouse. This year, it came in at just slightly over $12.5 million or about $460,000 lower or 3% lower. In terms of CapEx, in Q4, Costco spent approximately $850 million. And for all of fiscal ‘16, the retailer came in right at $2.6 billion. That $2.6 billion by the way, compares to $2.4 billion for the prior year fiscal year in ‘15. The estimate for fiscal ‘17 CapEx is in the range of $2.6 billion to $2.8 billion, so about the same level as compared to last year.

In terms of common stock repurchases for the fourth quarter, Costco purchased $131 million worth of stock or 856,000 shares at an average price just over $153 a share. For all of fiscal ‘16, we purchased $477 million of stock. That compares to $493 million in 2015 and $333 million in 2014.

Costco has maintained a relatively steady performance through 2016 in light of subdued consumer spending and retail sales. By expanding its retail square footage at roughly 3.5% over the last couple of years, this has helped stem the tide of sliding same-store-sales and the impact on total net sales and profits from foreign currency and food deflation headwinds. 

Most recently Guggenheim’s John Heimbockel had the following to say regarding Costco’s September sales results:

  • "The flat U.S. “core” result might raise some eyebrows but the segment was up against a strong 7% year-ago gain, placing the two-year gain at a respectable 7%," writes analyst John Heinbockel.
  • "As food deflation and the impact of the tobacco exit ebb over the next six months, we would expect the 'core' comp to rebound, the principal question being to what degree? 3-4% would be a reasonable target," he adds.
  • Heinbockel thinks Costco's share price could slip a little bit further as the retailer faces more near-term data comparisons before reaching an inflection point in early 2017.

Since initiating a position in COST shares at $162, I have added to my position on the significant pullback at $144 a share. This addition effectively lowers my cost average to roughly $153 a share, ex-dividend. 

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