We’re upping our price target on Costco after another steady quarter fortifies our thesis

By admin On Sep 27, 2024

Costco on Thursday reported ho-hum quarterly results, with a small topline miss being more than offset by strong profitability to deliver an earnings beat. The report didn’t blow us away, but it still offered plenty of reminders on why Costco investors should stick around. Total revenue in its fiscal 2024 fourth quarter totaled $79.7 billion, missing analysts’ expectations of $79.97 billion, according to estimates compiled by LSEG. Sales were up 1% year over year, though the year-ago quarter had an additional week, skewing the comparison. Earnings per share in the 16-week period came in at $5.29, topping analysts’ forecasts of $5.08, LSEG data showed. The earnings result includes a non-recurring tax benefit of 14-cents per share. But even after removing it, the bottom line results were still better than expected. Costco Wholesale Why we own it: Costco is the best-run retailer in the world, with a business model focused on offering its members a relatively small universe of products at hard-to-beat prices. Costco has succeeded for decades, but the high inflation of recent years has made the company’s value-focused ethos really shine. Competitors: BJ’s Wholesale , Walmart and fellow Club holding Amazon Last buy: June 15, 2020 Initiation date: Jan. 27, 2020 Shares of Costco edged lower in extended trading Thursday by about 1.4%, to around $889 each, adding to modest losses during the regular session. The stock — one of our top-performers this year, up nearly 37% — closed at a record high of $917.08 per share Monday. Bottom line There’s nothing to be concerned about with Costco’s fourth-quarter results, even though sales came up short. The miss was marginal and more than offset by solid year-over-year expansion at both the gross margin and operating margin levels, which enabled the earnings beat. When normalizing for the extra week in last year’s fourth quarter and removing the aforementioned tax-related benefit, adjusted earnings per share were up 12.6% on an annual basis. Membership fee income of $1.5 billion was a tad light, but keep in mind the recent fee hike — announced in July and implemented Sept. 1 — is not factored into Thursday’s results. To be sure, its impact in Costco’s now-underway fiscal 2025 will be “minimal” early on, CFO Gary Millerchip noted on the call. “The vast majority of the benefit will come in the back half of fiscal year 2025 and into fiscal year 2026.” We left the earnings call with increased conviction that Costco remains a top destination for anyone seeking the most bang for their buck — and these days, who isn’t? Costco is staying true to its mission and finding new ways to reduce its own costs. The company is then passing those cost savings on to its members, attempting to cut prices whenever possible and otherwise keep them steady. If Costco’s suppliers are expected to try lowering prices when they can, then “we’re going to start with setting that example and showing the benefits of investing in price and driving unit volume. So, we are doing that,” CEO Ron Vachris said. “But we are also seeing great support from our suppliers and our partners around the world that are also interested in driving their business and using Costco as that partner to get that done.” Member demographics were a bright spot on the call. About half of new members in fiscal 2024 were under the age of 40, finance chief Millerchip said. “This percentage has been growing since Covid-19 and has lowered the average age of our member over the last few years.” The younger Costco can capture a new member, the better chance it has at keeping that member’s loyalty over time. COST YTD mountain Costco’s year-to-date stock performance. Costco shares aren’t cheap — a fact that motivated a recent analyst downgrade — but we continue to see further upside ahead. The reason is simple: Consumers will keep flocking to Costco in search of value, and investors will in turn continue to reward management’s ability to drive customer loyalty with a premium price-to-earnings multiple. Plus, the benefit from slightly higher membership fees haven’t flowed into the business yet. Put it all together, we’re increasing our price target on the stock to $950 a share from $875. We are keeping our 2 rating on the stock for the time being, meaning we’d wait for pullbacks before buying additional shares. Quarterly commentary Costco’s fourth-quarter gross margins of 11% edged out the Wall Street estimate of 10.94%, up 39 basis points on a reported basis and 33 basis points when excluding gas inflation. Both figures are worth highlighting, but the ex-gas number offers a better look at Costco’s underlying fundamentals given price of oil is out of management’s can control. A basis point equals 0.01%. Core merchandise was a five basis point headwind to Costco’s gross margins on a reported basis, while its 2% reward program for certain members was a four basis point headwind. However, this was more than offset by a 44 basis point improvement in Costco’s ancillary and other businesses — including gas stations, pharmacies, food courts, travel and hearing aid centers. And finally, last in, first out (LIFO) inventory accounting was a five basis point tailwind. Adjusted same store sales growth of 6.9% outpaced expectations, as an increase in traffic was only partially offset by a small decrease in average ticket price. The supply chain was a topic of conversation on the call, with management noting that the Red Sea remains a pain point (remember, shipping containers in that area had to deal with Houthi rebel attacks from Yemen). While any further disruptions could increase ocean freight rates down the line, employees have done a very good job insulating the company from the recent price increases “with good solid contracts for this year.” Moreover, executives said spot prices — what they’d pay if they were to sign contracts now — appear to have peaked and are starting to come back down. The current inflation dynamic is similar to what we saw last quarter, according to management. A slight increase in the price of food and sundries was offset by a decrease in the price of nonfoods, resulting in roughly zero overall inflation. Thursday marked Costco’s first conference call since the long-awaited membership fee hike became a reality. While it’s too early to determine the impact, we continue to expect little resistance from members because of the incredible value Costco provides. That’s especially true when it comes to the Kirkland Signature brand, which is still growing faster than the business as a whole. Millerchip ticked off many examples of Kirkland Signature products that saw price reductions in the quarter, such as macadamia nuts, a three-liter bottle of Spanish olive oil and two-pack baguettes. Additionally, the finance chief said Costco’s “commitment to sustainability” has led to some product packaging redesigns that use less plastic, giving the team an opportunity to cut prices. Laundry packs are one example where this happen, Millerchip said, going to $18.99 from $19.99. In other words, not only are we seeing disinflation at Costco, where the rate of price increases are slowing, we’re actually seeing several examples of deflation, which means prices actually come down. In the quarter, Costco’s membership renewal rate in the U.S. and Canada came in at 92.9%, a tick lower than the 93% rate observed in the third fiscal quarter, while worldwide held constant at 90.5%. Millerchip attributed the slight declines in U.S. and Canada renewals to online membership promotion that ran for a short time in 2023 that resulted in 200,000 new sign-ups at the time. “As those members entered the renewal rate calculation during Q4 fiscal year 2024, the lower renewal rate for that cohort, which is typical for digital promotions, had a negative impact on the overall U.S renewal rate. Outside of those sign-ups, there were no meaningful changes in the U.S renewal rate.” Costco’s warehouse expansion resulted in 29 net new locations in fiscal 2024, including the opening of it’s first location in Maine, which brought the company’s U.S. presence to 47 states. Management expects to add another 26 net new buildings in fiscal 2025, with 12 of those locations being outside of the U.S. (Jim Cramer’s Charitable Trust is long COST. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

Customers walk by the membership counter at a Costco store on July 11, 2024 in Richmond, California.

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