Analysis: COST

Thursday night Costco Wholesale (COST) reported fiscal third-quarter results that were simply terrific with clear signs it continues to win consumer wallet share, membership renewals continuing to improve, and more plans to expand its warehouse footprint. All in all it was a solid quarter, however, the shares are trading off Friday morning more than likely because the company has opted to put an expected membership price increase on hold for now. We'll get more into the rationale for that below, but given the expectations as we hit the five-year anniversary of the last membership price increase, some are not pleased and we suspect others will have to adjust their models to account for what will likely be a later-than-expected membership fee hike.

We recently added to the portfolio's COST position, and if the current position size weren't as large as it is we would be using today's pullback to add even more following the quarterly results. With COST shares still well off their recent highs, and the business firing on all cylinders, we would suggest members that are underweight the shares use Friday's pullback to square up their position sizes relative to the portfolio's. We continue to rate COST shares a One and our long-term price target remains $620.

Now let's dig into the quarter results...

May-quarter results from Costco topped consensus expectations led by total company comparable sales, which, excluding impacts from changes in gasoline prices and foreign exchange, rose 10.8% year over year. Reported revenue came in at $52.6 billion for the quarter, up 16.2% vs. the year-ago quarter with Net Sales up 16.3% and Membership Fees rising 9.2% year over year. Ticking through other key metrics, for the quarter, the company's U.S. adjusted comparable sales totaled +10.7% and its adjusted e-commerce comparable sales were +7.9%. Average transaction amounts were up 7.6% worldwide and up 10.4% in the U.S. Best performing categories in Q3 were candy, sundries, tires, toys, jewelry, kiosks, home furnishings, apparel, bakery and deli. Underperforming departments were liquor, office, sporting goods and hardware, all of which were quite strong a year ago.

Membership fee income rose 9.2% year over year to $0.984 billion, accounting for 55% of the company's operating income during the quarter vs. 54% in the year-ago quarter. Membership renewal rates hit an all-time with the U.S. and Canada renewal rate at 92.3%, up 0.3% sequentially. The global membership renewal rate rose 0.4% quarter over quarter, coming in at 90% for the first time. Exiting the quarter, the number of member households and cardholders stood at 64.4 million paid households and 116.6 million cardholders, both up over 6%, compared to a year ago. We chalk that up to the company's continued warehouse expansion efforts, with plans to add more in the coming quarter, as well as more consumers flock to Costco to stretch their disposable spending dollars. On the new warehouse front, a key driver of membership and membership fee revenue, Costco reaffirmed plans to add a total of 24 net new locations, which points to another 10 locations during the current quarter. The additional units added during the May quarter along with those targeted for the current one as well as the company's continued footprint expansion bode well for membership fee income continuing to rise in the coming quarters.

On the topic of increasing its membership fee, which it has typically done every 5-6 years, Costco had nothing new to announce, sharing that given the current environment it is not the right time. However, as the company approaches the 5.5 year mark, there will be more internal conversations. That suggests to us there will be an eventual price increase potentially in the first half of 2023 as consumers aren't feeling as much inflationary pressures. While some will be disappointed by this lack of news, we see it as Costco doing the right thing for its membership, a key driver of its earnings power. Should we get word of pending membership price increase in the coming quarters, it will lead to even more favorable membership fee revenue comparisons in calendar 2023. Given the impact of that segment on the company's bottom line, it points to another reason why Costco's EPS in 2023 should continue to chug higher.

Inventories have been a big topic as retailers have reported their quarterly results. At Costco, inventories at the end of the May quarter were up 24% year over year but stood modestly higher compared to November and February quarters unlike a number of other retailers. We also have to factor into the equation that exiting the quarter, Costco operated 830 warehouse locations vs. 809 exiting the April 2021 quarter. This suggests the company has kept a tight rein on its inventories and shouldn't suffer the same margin compression other retailers are likely to as they look to work down those bloated inventories.

Costco also said it will announce its May sales results on Sunday, May 29, which means we'll have some thoughts on those figures when we return from the Memorial Day weekend.

Action Alerts PLUS is long COST.