Pandemic Triggers Compromises in Costco’s ‘Magic’

The effects of the coronavirus—from social distancing and stay-at-home mandates to supply congestion, travel restrictions, economic distress and more—together have presented a unique set of challenges to a unique kind of retailer.

Costco Wholesale—which, in “normal” circumstances, relies on enviable store traffic and the services, gasoline, high-ticket impulse buys, free samples and food court purchases their shoppers make or what one analyst called “the magic” of Costco—saw the pandemic exert compromises in all of those areas during its fiscal third quarter. Though Costco managed to drive increases in sales and comps in the period, largely on food sales, early-quarter stockups and a small but fast-growing e-commerce business, the Issaquah, Wash.-based company saw earnings dinged in the period.

Chris Mandeville, an analyst reviewing the financial results for Jefferies, called Costco a “victim of its own success.”

In a conference call this week, Costco Chief Financial Officer Richard Galanti said some of those compromised departments—including sampling in a new form he declined to detail—would gradually reappear. And while the pandemic kept some shoppers out of clubs—and contributed to a tenfold increase in same-day grocery delivery in the period—Costco’s spacious stores and superior value proposition would serve it well over the long term as the company and its shoppers adjust to what he predicted would be “two or three different new normals” in the coming months and years.

“We’ve been fortunate that we’ve been open,” Galanti said, according to a Sentieo transcript.

“At the end of the day, it’s a value proposition,” he added. “Our average gross margin is in the very low double digits, 11% or 12%, implying … a 13% or so markup. Traditional retail grocers are in the mid- to high 20s, and other big boxes are above that. And regular retail is way above that.”

Costco’s non-fuel same-store sales in the quarter ending May 10 increased by 7.1%—a figure that came in considerably below that of rivals such as BJ’s Wholesale Club ( 27% comps for the period ending May 2) and Sam’s Club (up 12% in the quarter ending April 30). Net earnings of $838 million were down by 7.5% on a 7.3% sales increase to $36.5 billion.

Analyst Scott Mushkin of R5 Capital noted that BJ’s outsized gains were aided in part by clubs that, until the pandemic, had more capacity to grow and a higher reliance on grocery items than its club rivals.

“Costco, in our opinion, is one of the best retailers in the world, and we continue to have incredible admiration and respect for the current and former management teams,” Mushkin said in a separate note to clients this week. “With that said, the COVID world is not in our view constructive for a company that thrives on heavy traffic to its crowded stores where members are tempted to impulse purchase unique, well priced, merchandise. This is in many ways the Costco magic.”