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COST: Costco Breaks the Cycle

Published Oct 8, 2014

Even though it is trading at a 24x multiple on a day where retail dinosaurs J.C. Penney(JCP) and Sears (SHLD) seem to be losing the good fight, Costco (COST) is looking pretty outstanding.

This morning, after months of incredibly consistent same-store sales but lagging profit growth, Costco reported a long-awaited earnings-per-share (EPS) beat. The naysayers on Membership Fee Income were proven wrong today as that metric beat handily, increasing more than 7%. Remember, Costco derives most if its profit from membership fees.

The other beat was due to gross margin, which increased 20 basis points, year over year. That metric is also important as food inflation has been a pressure that the company has not shifted to consumers — yet the company still showed improvement on product margins. The bottom line is that you can pick on the valuation of this company,  but where else in retail are you seeing a consistent 4% traffic increase combined with 2% average unit retail increases?

September comps (excluding gas and foreign exchange (FX)) also did not disappoint increasing 6% for the US. While some may point to the drag of cheaper gasoline prices on the headline comp number I would point out cheaper gas prices help consumers spend on discretionary items.

Costco is not just riding a retail wave. Consider Sam’s Club recent results. Traffic was negative for the most recent quarter and overall comps were flat. Clearly, cheaper membership fees at Sam’s are not a market share driver. As Sam’s is working on a cash back program to drive traffic and market share, I am not worried for Costco.

Simply put, the warehouse of treasure hunts has a higher income consumer (at $100,000) and those consumers are willing to pay a few more bucks for premium product, great prices and superior customer service. The fact that Costco actually pays its employees well doesn’t hurt. What is the saying? Happy wife, happy life. In retail translation, we say: happy employees, happy consumers.

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