Costco Unpacks Elements of Its Improving Performance

Though some ancillary categories and services like travel remained adversely affected by the pandemic, foot traffic is on the rebound again at Costco Wholesale, where higher sales and better margins in fresh foods triggered better-than-expected financial results in its fiscal fourth quarter.

As previously reported, the Issaquah, Wash.,-based membership warehouse chain saw sales improve by 12.5% and U.S. comparable club sales excluding fuel increase by 13.5% during the 16-week period which ended Aug. 30. Higher volume of fresh food sales sparked the comp increase, with the sell-through reducing waste and labor expense lifting merchandise margins in the quarter, which in turn sparked higher-than-expected earnings of $1.4 billion on $532.3 billion in sales.

Those figures helped Costco sustain higher expenses related to the pandemic, including a $2-per-hour wage premium for associates it expects to continue paying through the current quarter.

Physical store traffic, which had dipped earlier this year amid pandemic precautions, including reduced opening hours and capacity limits, increased by 1.2% in the quarter in U.S. units but by 3.1% in the month of August, officials said, indicating the big chain was approaching some sense of “normalization,” with paid members again relying on the combination of quality at a value Costco represents for them.

Shoppers were also increasingly turning to e-commerce at Costco. Digital sales in the quarter were up by 90.6% and by 120% when including food sales executed via same-day delivery from Instacart. “Total online grocery grew a very strong rate in Q4—several hundred percent,” Chief Financial Officer Richard Galanti said in a conference call, according to a Senteio transcript.

Costco has come up against some market skepticism given its deliberate pace of online capabilities, particularly as store traffic was constrained.

“It must develop the ability to capture online at least part of its store experience that historically drove impulse purchases in its warehouses,” Scott Mushkin, an analyst for R5 Capital, said in a note to clients. “With that said, Costco still remains one of the best retailers globally, exhibiting plenty of potential for club growth both domestically and internationally. Its management team has shown itself to be very capable of adapting to changing consumer preferences, even when done at a more conservative pace.”

Galanti acknowledged the growth pace of same-day fresh delivery despite the boom that was down from a peak three months ago, but added he expects that some portion of the sales are here to stay. Online offering, where available, also appears to be factor in driving new memberships—lifeblood for a club retailer—so Costco is supporting it with more promotions for online shoppers, he said.

He also acknowledged Costco still had room to get better at connecting with shoppers digitally.

“If you go back three or four years ago, I don’t think we had good email addresses for much more than one-third of our member base and we didn’t focus on that kind of stuff. Today, we have well over 60% and growing. We now require you, when you sign up, and more members are signing up online than in-store in general anyway ... you sign up with an e-mail address. So we’re doing a lot more to collect and gather those email addresses and then communicating with them more often. So that’s probably the single biggest low-hanging fruit.”

Email marketing helps both online and in-club sales, he added. “Anecdotally, I can’t tell you how many people have mentioned to me how they love [same-day delivery], and they may very well be shopping same-day fresh or same-day whatever from their local supermarket as well. But we’ve got a lot of great items on there and it's hitting a chord.

High volume sales in fresh foods—virtually and in-club—was the most powerful driver of Costco’s financial performance in the quarter. “Two components of cost of sales in fresh is labor productivity and spoilage. We don’t have spoilage. We sell out, not literally, but almost literally to the piece …  and so you’re not throwing stuff away. It’s a great business from a gross margin dollar perspective, given the sales strength in it,” Galanti said.

Costco’s new fiscal year will also be a busier than usual one on the new-store front, in part because of some pandemic-related delays affecting its pace of rollouts. For the year ending Aug. 30, Costco opened 16 total units, including three relocations. Galanti said Costco expects to add about 20 net new stores, with three relocations this year.

He told analysts he expected Costco would open between 20 and 25 units for the next five years, with “a little more than half" of those planned in the U.S.