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Why You Shouldn’t Worry About Costco Stock

by WOOWinvest
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Why You Shouldn't Worry About Costco Stock

The market crash has pushed stocks into a bear market, which has spooked many investors as shares of strong companies with solid earnings tumbled. It’s a market that appears to have no safe haven as the nebulous specter of inflation casts a shadow over the broader market, but pandemic stocks, tech companies and the retail sector in general.

Costco (COST) – Get the Costco Wholesale Corporation Report Not spared the fall. While the warehouse club is operating almost as usual, steadily adding members while retaining existing ones, the chain’s shares have fallen 22.83% over the past six months.

That’s a big drop for a chain that has been a very stable stock, often paying dividends alongside its rise. However, the drop in Costco’s stock price has nothing to do with the company’s performance. Instead, the company has fallen victim to widespread concerns about the retail industry.

Target (TGT) – Get Target Company ReportFor example, its shares fell more than 25% after reporting its first-quarter results. The chain’s same-store sales rose, which was impressive as that metric rose 22.9% in the last quarter. The retailer has faltered on the profit front as revenue halved from a year earlier due to rising costs and supply chain issues.

Never mind that Wall Street has seen Target’s strengths as weaknesses (making money and acquiring customers impressive in this case), let alone Costco shareholders.

Why is Costco so powerful?

Retail stocks including Target and Costco have been hit hard by higher prices (inflation), supply chain issues and concerns about falling consumer spending. These are real concerns, but Costco has a lot of protections against them. The Warehouse Club operates on a membership basis. Its profits mostly come from selling memberships, not merchandise from members.

Costco promises members a low price in exchange for membership fees. The company offers limited options to lower prices and has enormous bargaining power with suppliers.

Inflation could push up the prices of some of Costco’s key commodities, but the company could simply pass on those increases without raising prices. This makes the chain a value proposition for shoppers because these factors affect all retailers.

CFO Richard Galanti said on the company’s second-quarter earnings call that Costco has been able to maintain its own gross margins.

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“Moving down to the gross margin line. We reported a 32 basis point year-over-year decrease in gross margin for the second quarter, but an increase of 5 basis points, excluding gas inflation,” he said.

Basically, the company has maintained profit margins except for gasoline (Costco is generally cheaper than anywhere else). Excluding gas, its same-store sales also rose 11.1%, along with an increase in revenue.

“Net income for the quarter was $1.299 billion or $2.92 per diluted share. Net income for the second quarter of last year was $951 million or $2.14 per diluted share,” Galanti shared.

Membership is a key metric for Costco

Unlike traditional retailers, sales are not a key metric for Target. Membership tells investors more than anything else about the health of a company. The warehouse club needs to retain members as well as add new members.

According to Galanti, it has already done so.

“In terms of renewal rates, they continued to increase. At the end of the second quarter, our renewal rate in the U.S. and Canada remained at 92%, up 0.4 percentage points from 12 weeks earlier at the end of the first quarter. Globally, It reached 89.6%, up 0.6% from the level at the end of the first quarter 12 weeks ago,” shared the CFO.

Costco’s renewal rate has risen as more members auto-renew. The Warehouse Club is also seeing more members opting for higher-priced executive members, “who, on average, have higher renewal rates than non-executive members,” Galanti shared.

Membership is also growing (steadily), according to the CFO.

Looking at the number of members, member households and total cardholders at the end of the second quarter, the total number of households was 63.4 million, an increase of 0.9 million from 62.5 million 12 weeks ago; the total number of cardholders at the end of the second quarter was 1.148 billion, an increase of 1.7 million from 113.1 million 12 weeks ago. Paid executive membership was $27.1 million at the end of the second quarter, an increase of $644,000 over the 12 weeks at the end of the first quarter. By the way, executive membership is now 42.7% of our total membership and 70.9% of our total sales.

So while Costco’s stock price has been hurt by broader concerns and a generalized market panic, the chain’s business hasn’t been affected. In a scary environment for investors, you can argue that Costco is one of the safer bets, as long as you’re willing to be patient.

In the short term, stock prices may not reflect actual operating results. Over time, however, Warehouse Club will return to steady stock gains while paying a dividend (and possibly a bonus special dividend).

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