Analysis: COST

Costco (COST) reported better-than-expected fiscal fourth-quarter results after the closing bell Thursday. Total revenue of $62.675 billion (+17.4% YoY) was higher than estimates of $61.41 billion, and earnings per share of $3.76 (+20% YoY) exceeded estimates of $3.57.

It's worth noting that net income was hit by an $84 million, or $0.14 per share, pre-tax write-off of certain IT assets.

Over the full 16-week period of the quarter, adjusted comparable sales, which exclude impacts from changes in gasoline prices and foreign exchange, increased by 10.3% in the United States, 6.7% in Canada, and 7.3.% in other international, leading to a total company comp of 9.4%. E-commerce-adjusted comparable sales grew by 8.8%. That e-comm number may seem low, but remember Costco lapped a quarter where sales grew 91%.

Traffic, or shipping, frequency in Costco's warehouses inflected and increased 9.2% worldwide and 8.8% in the United States. Costco's average transaction, or ticket, including gas inflation and foreign exchange, grew 5.8% worldwide and 5.6% in the United States.

Before going further, it is always worth mentioning that Costco's stock tends to have a muted reaction to the quarterly reports. Rarely are there any fireworks. Some may call this boring, but there is a good reason for this. In addition to quarterly earnings, Costco reports its comparable sales figures every month. Because of this transparency, a lot of the "news" gets priced into the stock ahead of the quarter. Still, the quarterly reports are worth digging into, as the numbers and management's commentary provide meaningful insight into the trends they are seeing, and that helps shape our view of the future.

Membership-fee income is an important number to watch, because this is a large source of profits from the company. Costco generated $1.234 billion in fee income this quarter, representing an increase of 11.6% YoY. The figure also beat estimates of $1.196 billion.

Another thing to track is when management might raise the price of its membership fee. We want to stay close to this, because it could serve as a mini-catalyst event. Historically, Costco increases its membership cost every five years, and the five-year anniversary of the previous fee hike was June 2017. According to CFO Richard A. Galanti, Costco is still "a little ways from thinking" about the next membership fee increase.

Costco ended its quarter with 111.6 million total cardholders, up from 109.8 million one quarter ago. And paid executive members ended the quarter at 25.6 million, representing an increase of a little over 1 million from the prior quarter.

Renewal rates were consistent with levels from the second quarter, with U.S. and Canada at 91.3%, up 0.3 of a percentage point from the third quarter. The worldwide renewal was at 88.7%, also up 0.3 of a percentage point from the third quarter. CFO Galanti said on the call that he believes renewal rates are benefiting from more members auto-renewing and also increased penetration of executive members, who tend to renew at a higher rate compared with non-executive members.

On the margin front, reported gross declined 32 basis points year-over-year. Margins were 5 basis points higher excluding gas deflation. Breaking down margins further, core merchandise margin declined 90 basis points or 57 basis points ex-gas inflation. The company said the driver of the decline was the shift in sales mix from core to ancillary, a reversal of the positive trend it saw last year when many ancillary services were closed due to COVID-19. This was similar to what Costco saw last quarter. Ancillary and other business reported a 44 basis point increase in margin, or 53 basis points ex-gas inflation.

Meanwhile, 2% Reward margins improved by 1 basis point, but declined 3 basis points ex-gas inflation. Other margin increased 18 basis points or 17 ex gas inflation. New to the gross margin change was LIFO, which Galanti said made its first return to the matrix in about 7 years. LIFO contributed a 5 basis points decline to gross margin, with and without gas inflation. Costco recorded a $30 million LIFO charge in the quarter, the first related charge since 2014 and was driven by continued inflationary cost prices.

In terms of core-on-core margin, Costco said margins were lower by 40 basis points, with nonfood up slightly and food and sundries slightly lower YoY. But fresh foods were the main driver of the decline as Costco is currently lapping a period of "exceptional" labor productivity and low product spoilage. In ancillary, Costco said margins were higher 44 basis points and up 53 ex gas inflation. Costco also noted improvements in the food court, optical, and travel.

Looking ahead, management reiterated its plan to open at least 25 net new units this fiscal year. Included in the plans is the second opening of a warehouse in China and France, as well as the first location in New Zealand. The relocation of five warehouses is expected, as well.

On the e-commerce side, management continued to praise its acquisition of Innovel, which it now calls Costco Logistics. This business continues to be a driver of big and bulky sales online. Management noted delivery increased 130% in the quarter and represents about one quarter of all sales on their e-commerce site.

On the supply chain, Galanti spoke to some of the well-documented challenges facing everyone in retail: port delays, container shortages, COVID-19-related disruptions, component shortages, labor cost pressures, you name it. Lead times are increasing, explaining why Costco has put limitations on items like bath tissues and Kirkland signature water. About inflation, Galanti said he estimates that overall price inflation of products Costco is selling is in the 3.5% to 4.5% range. That's up from 2.5% to 3.5% last quarter and the 1% to 1.5% seen two quarters ago. If inflation stays at this level for an extended period, Costco will likely raise prices. But if one thing is certain, Costco will always be the first one to lower prices and the last one to raise them.

Overall, it was another solid quarter from Costco. With renewal rates on the rise, it's clear that Costco is keeping the new members it picked up during the pandemic and increasing market share.

Shares are up $3, or a little more than half of 1% in after-hours trading in reaction to the positive quarter. The move puts the stock about 3% off its intra-day all-time high. Again, we are not surprised by the muted reaction, because that's Costco's track record. The one thing we hoped for tonight was an irrational pullback, so that we could buy shares at a discount, but that did not happen. We continue to believe Costco should be appreciated as one of the most consistent and defensive names in all of retail.

Action AlertsPLUS, which Cramer co-manages as a charitable trust, is long COST.