Costco's quarterly beat isn't enough to knock out the bears — here's what could

CNBC Finance

6 min read

Costco reported better-than-expected quarterly results on Thursday, driven by higher net sales, membership fee income, and gross margins. However, it wasn't enough to break the bearish narrative on the stock, which dipped less than 1% in the after-hours market. Total revenue in the company's fiscal 2026 first quarter increased 8% year over year to $67.31 billion, topping Wall Street expectations of $67.14 billion, according to estimates compiled by LSEG. Adjusted earnings per share (EPS) for the period ending Nov. 23 rose 11% from the year-ago period to $4.50, beating the consensus of $4.27, LSEG data showed. COST YTD mountain Costco YTD return Bottom line The quarter looked pretty down the fairway, with beats across key line items. If there's a bone to pick, it's the membership renewal rate, which has declined for several consecutive quarters and is expected to continue to drift lower in the months ahead. We don't view the dip in renewal rates as a warning sign that a Costco membership has lost its appeal. The ethos hasn't changed: deliver the most value to customers by offering quality products at the lowest prices. That's how the retailer consistently delivers strong comparable sales â with growth in both traffic and ticket â and market share gains. At the same time, we must acknowledge a slight slowdown in stores recently. Costco's U.S. sales for the November period increased 5.8% excluding gas and currency fluctuations, reflecting a significant deceleration from the 6.4% growth in October. Why we own it Costco is the best-run retailer in the world, with a business model focused on offering its members a relatively small universe of products at hard-to-beat prices. Costco has succeeded for decades, but the high inflation of recent years has made the company's value-focused ethos really shine. Competitors: BJ's Wholesale , Walmart , fellow Club holding Amazon Last buy: June 15, 2020 Initiation date: Jan. 27, 2020 During the conference call, management was adamant that the business hasn't lost its consistency and cautioned against reading too much into a single month's result. "If you look at every individual month, there were only two months in that last seven months that were outside of the range of 6 to 7%," CFO Gary Millerchip explained, adding that the company is seeing a "consistent pattern" in how members are shopping and behaving. Consistent mid-single-digit comp growth is the envy of almost every retailer. Still, a slight slowdown is viewed differently in the context of Costco's stock, which trades at a lofty price-to-earnings multiple of about 43. Even after Walmart 's outperformance this year, it still trades at a P/E of about 40. Both stocks trade at a hefty premium to the S & P 500's forward multiple of 23-24. It's possible that the government shutdown impacted October and November, and sales could rebound in the months ahead. However, the company is trying to counter the narrative that there has been a material slowdown in sales, and the paid membership miss doesn't help the debate. We walk away from the quarter with not enough to pound the table on the stock amid its recent slide, but enough to believe a comeback is likely. What could help improve the narrative is a solid-looking December sales release on Jan. 7. Until then, we are maintaining our 1 rating given our positive long-term view on Costco, but lowering our price target to $1050 from $1100 to reflect recent share price weakness. Commentary Total fiscal first-quarter comparable sales, an important metric for the retail industry, increased 6.4% on a company basis and on an adjusted basis, which strips out the effects of foreign exchange and gasoline prices. The comps were driven by a 3.2% increase in traffic and 3.1% increase in ticket sales. The increase in traffic reflects a deceleration from the prior quarter but remains healthy. Costco's digitally-enabled comparable sales were up 20.5%. By category, fresh food comps increased mid- to high single digits on a percentage basis in the quarter, while Non-food delivered a mid-single-digit increase. Some items with double-digit comp sales growth were gold and jewelry, special events, and health and beauty. Major appliances, tires, and small appliances posted high single-digit comp growth. On Kirkland Signature, Costco's private-label brand, the company launched 45 net items in the quarter. As mentioned, gross margins improved by four basis points to 11.32%, narrowly beating the consensus estimate of 11.31%. Gross margins also improved by four basis points, excluding gas deflation. If we look into the different components of the gross margin change, core merchandise margin was flat year over year, Costco's ancillary and other businesses (which include pharmacy, food courts, and travel) added seven basis points of improvement, and "last in, first out" (LIFO) accounting had a three-basis-point negative impact. Costco's paid memberships increased in the quarter, but not by as much as the market anticipated. Total paid memberships increased 5.2% year over year to 81.4 million but missed the FactSet consensus of 82.4 million. The decline in membership renewal rates might have contributed to the miss. The worldwide membership rate dipped to 89.7% from 89.8% one quarter ago, while the U.S. and Canada rate fell to 92.2% from 92.3% in the prior quarter. These declines help explain some of the sluggish paid membership trends. The same dynamics that have hurt renewal rates in past quarters continued into November. Costco has seen its renewal rates decline due to increased online memberships. The company's online shoppers skew younger and are more fickle, resulting in lower renewal rates than in-store customers. The good news is that management said the renewal decline was lower than anticipated because their targeted communications to expiring members are starting to have an impact. Still, this problem isn't going away anytime soon. The company expects a slight decline in overall rates over the next few quarters. Growth plans Costco opened seven new warehouses. It plans to open 21 more over the course of the fiscal year, bringing the total to 28. That would be one more than last year, but it's below the 30 new warehouse openings management originally planned to open. The company chalked up revisions to delays with a couple of buildings in Spain. Costco still plans for 30 or more net openings in future years and is expanding its real estate team to support this goal. (Jim Cramer's Charitable Trust is long COSTCO. 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. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

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Costco's quarterly beat isn't enough to knock out the bears — here's what could

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