Image Source: Mike Mozart
Wholesale food retailer Costco disappointed investors with its fiscal first quarter report as margin pressures outweighed strong comparable sales performance.
By Kris Rosemann
Shares of bulk food retailer Costco Wholesale (COST) faced material selling pressure following the release of its fiscal 2019 first quarter report December 14 as concerns over margin pressures outweighed its impressive top-line growth. Total company comparable sales, adjusted for changes in gasoline prices, foreign exchange rates and revenue recognition changes, grew 7.5% on a year-over-year basis in the quarter, and e-commerce sales leapt 26.2%. The company’s US operations led the way with 8.3% comparable sales growth, and total revenue advanced 10.2% from the year-ago period.
Despite the impressive top-line growth, Costco’s GAAP operating income was roughly flat in the quarter from the comparable period of fiscal 2018 at $949 million. Higher merchandise costs as a percentage of revenue were the key driver for the company’s GAAP operating margin to contract nearly three percentage points from the year-ago period to 27%. Management noted that an increase in competition on the fresh side of its business from both supermarkets and Sam’s Club (WMT) has been present in the past few quarters and is impacting margin performance. GAAP earnings per diluted share jumped to $1.73 in the quarter from $1.45 in the first quarter of fiscal 2018 thanks in large part to a materially lower tax bill.
We currently value shares of Costco at $187 each, and we’re not looking to add exposure to the company at this juncture, though we do admire the business. It has a number of strengths: strong member renewals, fantastic employees that enjoy the higher-than-average pay, great merchandise, and a treasure-hunt atmosphere that consumers love. Its image speaks of quality, and the public often uses Costco as an example for excellent employee relations. Costco targets merchandise that produces high sales volumes and rapid inventory turnover. This turnover, when combined with efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouses, enables Costco to operate profitably at significantly lower gross margins than peers.
The company doesn’t offer a very competitive dividend yield, which sits at less than 1.1% as of this writing, but it has paid multiple massive special dividends of $7 per share, $5 per share, and $7 per share in special dividends in fiscal years 2013, 2015, and 2017, respectively, all of which drastically overshadow its current annual per share dividend of $2.28. Costco’s Dividend Cushion is an impressive 2.7 thanks to solid free cash flow generation (averaged ~$2.6 billion in fiscal 2016-2018 compared to annual run rate dividend obligations of $689 million) and a net cash position of $772 million at the end of fiscal 2018, but the measure does benefit from relatively low dividend obligations.
Food Retailers: CASY, COST, CVS, GNC, KR, SYY, TGT, UNFI, VSI, WBA, WMT
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.