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Costco sees earnings jump in second quarter

Warehouse club giant raises hourly pay, looks to boost e-commerce operations

Earnings soared at Costco Wholesale Corp. in the fiscal 2019 second quarter, climbing well over the upper end of Wall Street’s forecast.

Costco said late Thursday that reported net income for the quarter ended Feb. 17 totaled $889 million, or $2.01 per diluted share, compared with $701 million, or $1.59 per diluted share, a year earlier.

Analysts, on average, had projected adjusted earnings per share of $1.69, with estimates ranging from a low of $1.59 to a high of $1.76, according to Refinitiv/Thomson Reuters.

The Issaquah, Wash.-based warehouse club chain also posted strong earnings for the fiscal 2019 first half. For the 24-week period, net income rose to $1.66 billion, or $3.74 per diluted share, from $1.34 billion, or $3.04 per diluted share, a year ago.

Second-quarter net sales came in at $34.63 billion, up 7.3% year over year from $32.28 billion. The increase was slightly larger for the half, as net sales grew 8.7% to $68.94 billion from $63.40 billion in the prior-year period.

Comparable-store sales advanced 5.4% overall in the second quarter, led by a 7.4% gain in Costco’s core U.S. business. Same-store sales dipped 0.3% in Canada but inched up 0.7% in Costco’s international segment. E-commerce sales jumped 20.2%.

On an adjusted basis, total comp-store sales rose 6.7% in the quarter, including increases of 7.2% in the U.S., 6% in Canada and 4.8% in the international business unit. Adjusted e-commerce sales were up 25.5%. The adjusted figures exclude the impact of changes in fuel prices and foreign exchange, as well as an accounting change concerning revenue recognition.

For the first half, same-store sales climbed 7.1% overall (7% adjusted), with U.S. comp sales rising 9.2% (7.6% adjusted). E-commerce sales in the 24 weeks surged 25.9% (25.8% adjusted).

“Looking at the core merchandise categories in relation to their own sales, or what we call core-on-core, margins year over year were higher by 8 basis points,” Costco Chief Financial Officer Richard Galanti (pictured) told analysts in a conference call late Thursday. “Within the four key subcategories, both food and sundries and fresh foods were up a little, and softlines and hardlines were down a little.”

Richard_Galanti_Costco_CFO_PhotoCreditCostco.pngThe company celebrated its results by announcing that it is raising the minimum wage for its employees for the second time in less than 12 months; the new minimum is $15 an hour. Last June, the minimum wage was raised to $14 from $13 an hour.

Membership fee income increased by 7.3% to $768 million for the second quarter and by 8.4% to nearly $1.53 billion for the first half. As of the period’s end, Costco’s member base totaled 52.7 million, up about 1% from a year earlier, with the U.S.-Canada renewal rate edging up to 90.7% from 90.5%.

In February, comp-store sales were up 3.5% year over year, reflecting a 6% gain in the U.S., flat results in Canada and a 5.9% decrease in the international segment, Costco said. On an adjusted basis, comp sales for the month grew 4.6%, including increases of 5.7% in the U.S. and 4.8% in Canada and a 1.2% decline in the international unit. February e-commerce sales rose 24.2% (21.6% adjusted).

Overall February net sales rose 5% to $10.72 billion. Costco noted that February sales reflect negative impacts of 1% from inclement weather in the U.S. and Canada and 4.5% from an earlier Lunar New Year/Chinese New Year.

Galanti noted that Costco’s e-commerce business continues to see growth not just in sales but also in profit, orders and other metrics. He cited grocery, consumer electronics, hardware, health and beauty aids, tire and automotive, toys, seasonal and apparel as top-growing categories in the second quarter.

“We've now passed our one-year anniversary on the grocery launch, which was a year ago in October. Same-day grocery delivery is now available to members within a short drive in 99% of our U.S. locations. Two-day grocery is available anywhere throughout the continental United States. And while still these are small pieces of our total business operation, they're growing nicely. We now have grocery shipments to all 50 states,” he said.

“We continue to improve our online and inline cross-marketing initiatives, and we think that's continuing to drive our business,” Galanti added. Costco also has expanded its product selection for click-and-collect service and continues to test pickup lockers in 10 stores.

E-commerce now accounts for 5% to 6% of Costco’s business, and the company is bolstering operations to support online channel growth, according to Galanti. Within the past couple of months, Costco opened an automation fulfillment operation at its Mira Loma distribution center. “This is for small packages for e-commerce, and we plan to do two more of those this year at other depots,” he said.

Costco currently fulfills two-day grocery delivery from 10 or 11 of its business center locations around the country but plans to move that operation to six of its distribution depots over the next few months, Galanti told analysts on the call. “I think we've done the first one, and we've got several more planned right around end of spring, beginning of summer,” he said. Same-day grocery delivery is handled by Instacart.

During the second quarter, Costco opened one new club in Coral Springs, Fla., and relocated a Miami location.

“In Q3, we have three new openings planned and no re-los. We actually opened this morning in Bayonne, N.J. In late April, we plan to open our 16th location in Korea and, in early May, our 11th location in Australia,” Galanti said. “The big expansion quarter for us this year is Q4. We plan to open a net of 12 units — 14 openings, including two re-los — including our first opening in China in Shanghai, in the city of Minhang, and also our third unit in Spain, which would be our second in the Madrid area.”

Costco ended its fiscal 2019 first half with 770 warehouse clubs overall, including 535 in the U.S. and Puerto Rico, 100 in Canada, 39 in Mexico, 28 in the United Kingdom, 26 in Japan, 15 in Korea, 13 in Taiwan, 10 in Australia, two in Spain, and one each in Iceland and France. The retailer also operates e-commerce sites in the U.S., Canada, the United Kingdom, Mexico, Korea and Taiwan.

“Second-quarter 2019 was a clean beat driven by comp upside and strong core gross margin expansion, post six quarters of sizable declines,” Jefferies analyst Christopher Mandeville said in a research note on Friday. “That said, one-, two- and three-year comps have largely been trending lower since November, MFI continues to slow and SG&A is now set to accelerate as the company invests for the long term, likely offsetting much of any further gross margin gains in coming quarters.”

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