Costco ‘doing as good a job as anyone’ in reining in prices

Costco Wholesale generated solid traffic and membership growth in the third quarter and continues to more than hold its own with competitors in a tough consumer environment, according to Chief Financial Officer Richard Galanti.

Slower sales in discretionary categories, notably big-ticket items, reined in sales growth during the quarter ended May 7. Net sales inched up 1.9% year over year, compared with annual upticks of 6.5% and 8.1%, respectively, for the fiscal 2023 second and first quarters. Likewise, Costco’s overall comparable sales rose just 0.3% ( 3.5% excluding fuel and foreign exchange) on an annual basis, reflecting a 0.1% dip in the United States ( 1.8% adjusted).

“In terms of third-quarter comp-sales metrics, traffic or shopping frequency remains pretty good, increasing 4.8% worldwide and 3.5% in the U.S. during the quarter. Our average daily transaction or ticket was down 4.2% worldwide and down 3.5% in the U.S., impacted in large part from weakness in bigger ticket non-foods discretionary items,” Galanti told analysts in a conference call after Thursday’s market close. (Call transcript provided by AlphaSense.)

Big-ticket sales malaise takes toll on e-commerce

Online sales were particularly hard-hit by the drop-off in larger-dollar-ring discretionary sales, he noted. For the third quarter, e-commerce sales sank 10% (-9% adjusted) year over year, following annual decreases of 9.6% (-8.7% adjusted) in Q2 and 3.7% (-2% adjusted) in Q1.

“In Q3, big-ticket discretionary departments—notably majors, home furnishings, small electrics, jewelry and hardware—were down about 20% in e-com and made up 55% of e-com sales. These same departments were down about 17% in-warehouse, but they only make up 8% of in-warehouse sales,” Galanti explained.

Companywide membership fee income climbed 6.1% to $1.044 billion in the third quarter. And at the end of the period, renewal rates stood at 92.6% in the U.S. and Canada and 90.5% worldwide—the same “all-time-high” renewal rates recorded for the second quarter, reported Galanti.

“Membership growth continues. We ended Q3 with 69.1 million paid household members and 124.7 million cardholders, both up approximately 7% versus a year ago,” he said. “At third quarter-end, we had 31.3 million paid executive members, an increase of 681,000, or 57,000 per week, during the 12-week fiscal third quarter. Executive members now represent a little over 45% of our paid members and approximately 73% of worldwide sales.”

As at other mass retailers, Costco has seen stronger sales of food and other essentials and weaker sales of discretionary categories, namely big-ticket general merchandise. / Photo: Shutterstock

Buyers go extra mile to hold line on pricing

Costco continues to drive traffic and add members through the strong value proposition of its club model, which resonates with consumers amid still-elevated—albeit declining—inflation, according to Galanti.

“Inflation continues to abate somewhat. You go back a year ago to the fourth quarter of 2022 last summer, we had estimated that year-over-year inflation at the time was up 8%, and by Q1 and Q2 it was down to 6% and 7% and then to 5% and 6%,” he said in the call. “In this quarter [Q4 2023], we’re estimating year-over-year inflation in the 3% to 4% range. We continue to see improvements in many items, notably food items like nuts, eggs and meat, as well as items that include as part of their components commodities like steel and resins on the nonfood side.”

On the pricing front, Costco’s merchants are “pushing the boundaries each day” with margins and leveraging vendor monies to drive business, Galanti said in response to an analyst’s question.

“We feel that we’re doing as good a job as anyone out there, given the item nature of our business, to lower prices for our members and hopefully drive sales,” he explained. “Certainly, right now, we’ve always been a little bit over-indexed in bigger-ticket discretionary items, compared to others. If you look at our fresh foods and food and sundries [merchandise categories], they are in the mid- to mid-high singles. If you look at the nonfoods and some of the ancillaries, notably gasoline—which is deflation, 11% year-over-year deflation in gas prices—that’s in the mid-single negative. So it all adds up to where it is. Every day, we look to drive sales.”

Costco took a 50-cents-per-diluted-share charge (pretax) in Q3, which pulled down net earnings, as it ended charter shipping begun in 2021 to address overseas freight challenges during the pandemic. However, the move now brings more flexibility on the sales side, Galanti pointed out.

“In the third quarter, we concluded that it would be appropriate to completely discontinue the remainder of our charter shipping activities. As a result of this decision, we recorded an impairment charge for all remaining charter assets,” he said. “This decision allows our merchandising teams to take full advantage of the current shipping market rates as opposed to much higher contracted-carter rates. In turn, this allows us to do what we do best and lower prices for our members.”

More new clubs on the way

Issaquah, Washington-based Costco finished Q3 with a total of 853 warehouse clubs, up from 830 a year ago. For the year to date, the company opened 17 clubs, including three relocations, and operated 587 clubs in the U.S. and Puerto Rico.

“We have nine new buildings planned for our fiscal fourth quarter. That includes our north Tulsa, Oklahoma, opening this morning [May 25] and our fourth and fifth buildings in China, planned for June and August,” Galanti said in the call. “These Q4 planned openings will bring our full-year count to 26, or net of 23 [excluding relocations]. And that is made up of 13 in the U.S. and 10 outside of the U.S.”

Despite a bit of a slowdown, Costco stands well-positioned in the current retail environment, William Blair & Co. analyst Phillip Blee reported.

“While sales trends continue to decelerate on difficult comparisons in higher-ticket, discretionary categories, we believe the company’s ongoing momentum in traffic and stability in its membership model should ease investor concerns around potential difficulties lapping prior-year, elevated, fuel-related traffic to its warehouses,” Blee wrote in a research note on Friday. “We believe Costco’s leading value proposition—centered on low prices, high-quality products and its private-label brand—should fuel ongoing momentum in traffic as inflation-battered consumers continue to seek opportunities for savings.”