Costco again outshines its retail rivals, while rewarding shareholders

Published Thu, Dec 14 20236:54 PM EST

Costco Wholesale 's first quarter of its fiscal year 2024 came in better than expected, with beats on both the top and bottom lines. The results further demonstrated how the company shines in a challenging macroeconomic environment, with many other retailers under pressure from a weakening consumer, bloated inventory levels and theft. Furthermore, we were pleased to see Costco reward its shareholder base with a special cash dividend of $15 per share. Total revenue for the three months ended Nov. 26 increased 6.2% year-over-year, to $57.8 billion, beating analysts' expectations of $57.72 billion, according to estimates compiled by LSEG. Earnings per share (EPS) grew 16.6% year-over-year, to $3.58, beating analysts' forecasts of $3.42, LSEG estimates showed. Shares of Costco were up roughly 1.6% in afterhours trading, at $641.35 apiece. Based on Thursday's closing price of $630.78 a share, Costco stock has gained 38% year-to-date and trades near its all-time closing high of $642 made Wednesday. Bottom line This was another great quarter from Costco and we see no reason to change our view that you can't go wrong owning this stock for the long term. It's easily the most consistent performer in a volatile retail group because of its leadership in selling quality goods at value prices, which drives people to sign up for new memberships and spend more in its stores. The power of the Costco model is evident by its strong loyalty rates. The announcement of a special dividend was a bonus this evening and an event we've been counting on for a while. Anticipation of a membership-fee increase, which might come next year, could push the stock to higher levels from here. However, we are keeping our 2 rating on the stock — meaning we would wait for a pullback before buying up more shares — because it has had a huge run this year to new highs, and is likely to pause in order to digest those gains. Due to the Federal Reserve's dovish pivot on Wednesday, investors have shifted some of their attention to lower-quality names in retail that have lagged and could play catch up. We don't think this powerful rotation means sell Costco, however we recognize the stock could take a back seat to others that have not kept pace with its strong gains this year. We'll update our price target shortly. Quarterly commentary Costco releases its sales figures on a monthly basis, so the market always has a clear picture of the sales landscape when it comes time for the company to report quarterly results. What is harder to pin down is how margins fared. Costco's reported gross margins, excluding membership fees — which flow directly into profits — expanded 43 basis points from last year, to 11.04%. On the post-earnings conference call, Costco CFO Richard Galanti broke down all the levers of the quarterly margin performance. Core merchandise was a three-basis-point improvement on a reported basis, and three-basis-point decline excluding the fall in the price of gasoline from the year-ago period. Costco saw a small margin headwind from sales of fresh food and sundries, while nonfoods was a positive contribution to margins thanks to lower freight costs. On the big-ticket side, Costco noted that appliance sales were up 20% in the quarter, while television sales increased by a high-single-digit percentage. Sales of other electronics like computers fell by the a low-teen percentage. Costco's ancillary businesses — including gas stations, pharmacies, food courts, travel centers and hearing aid centers — provided a 24-basis-point improvement on a reported basis, and 22-basis-point improvement excluding gas deflation. Driving the tailwinds were gas sales and its e-commerce business. Costco's 2% reward program was a four-basis-point headwind to margins on a reported basis and three-basis-point headwind excluding gas deflation, a result of more sales to Costco's executive members. Last in, first out (LIFO) inventory accounting was a three-basis-point benefit on both sides. This was due to a $15 million LIFO credit in the quarter, compared to a small $500,000 charge last year. Finally, "other" was a 17-basis-point benefit on both sides, reflecting the lapping of a $93 million charge the company took last year to downsize its charter shipping activities. Costco's update on inflation was encouraging, as well. Last year, the wholesaler was contending with inflation of around 8% at its high, but it has steadily trended down since then. Last quarter, Galanti estimated inflation was about 1% to 2% higher year-over-year. Its estimate for the reported quarter was in the 0% to 1% range. What a difference a year can make. The Fed must like those numbers because Costco is not a retailer that would keep prices high to make a few extra bucks. It prides itself on being the last retailer to raise prices and the first to lower them. This concept is why we believe Costco continues to gain market share from peers and increase wallet share from consumers. That's evidenced by the company's traffic metrics, which increased 4.7% worldwide and 3.6% in the U.S., and also through its renewal rates, which ticked up in the U.S. and Canada and worldwide, to 92.8% and 90.5%, respectively. And there's plenty of room for Costco to keep expanding in both the U.S. and internationally The company opened 10 new locations in its first quarter and plans to open 23 more throughout the rest of the fiscal year. Moreover, with renewal rates as strong as they are, management always gets asked about when it will raise its membership fees. This question has come up on every post-earnings conference call for the past few years because it's something the company has traditionally done every five to six years. Costco last raised its fees in June 2017, so one could argue it is overdue. When asked about this on Thursday, Galanti reiterated it's a "when, not if" situation. We frequently talk about a membership-fee increase in our Costco discussions because that extra income can flow directly to Costco's bottom line, meaning higher profits and margins. Or in a more likely scenario, management will use most of those extra dollars to reinvest in the business and keep prices down, thereby increasing traffic and sales. Costco is a volume company, not a margin company. Our expectation is that Costco will raise its membership fees sometime next year, representing a potential catalyst. Finally, a second catalyst we've talked about hit this evening. Costco declared a special cash dividend of $15 per share, payable Jan. 12 for all shareholders of record as of Dec. 28. The $15 payment is a nice bump up from the $10 special cash dividend it declared in November 2020. The dividend will be funded entirely with cash on hand. The cash should help tide investors over, as we patiently wait for membership-fee increase. (Jim Cramer's Charitable Trust is long COST. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. 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