Costco Q1: Membership Model Muscles Through, But Can It preserve Momentum? (NASDAQ:COST)

Costco Wholesale Corporation (NASDAQ:COST) announced fiscal Q1 2024 results that once again beat expectations. Revenue grew 6.2% to $58.8 billion EPS of $3.58 beating by $0.16. Costco remains a non-stop company that continues to enlarge warehouses all over the world.

Comparable sales increased 3.8% YoY, excluding gas and foreign exchange effects.

Let’s peel back the layers of Costco’s FQ1 24 results and see why my Buy rating remains firmly in place. Buckle up, as we contrast the numbers to my forecasts and dissect the drivers behind the company’s continued success.

Background

On September 25, I published an article titled “Costco: A Stock That’s Too Hot To Handle.” In the article, I broke down Costco’s business model and how Costco is different from its competitors, explaining their Costco Membership. After a couple of days, I published the second article, “Costco: Fourth-Quarter Results Show Resilience, But Valuation Remains High (Rating Upgrade).” In the second article I summarized the fiscal fourth quarter of fiscal 2023, and I explained why Costco stock has a Buy rating.

FQ1 2024 Highlights

Costco reported consolidated revenue of $58.8 billion, up 6.2% YoY, primarily reflecting increased comparable sales, and expanding warehouses. The company is on pace to deliver a 7.5% revenue boost YoY.

Membership fee income increased $82 billion, or 8.2%, a 4 bps boost over the first quarter last year.

Membership growth continues, as Costco ended Q1 with 72 million paid household members, up 7.6% versus last year, and 129.5 million cardholders, up 7.1%, with consistent growth throughout the quarters. At the end of FQ1 24, Costco had 33.2 million paid Executive members, an boost of 939,000 during 12 weeks since Q4 end. Executive members now represent a little over 46% of the paid members and a little over 73% of worldwide sales.

In terms of renewal rates, at FQ1 end, the U.S. and Canada renewal rates stood at 92.8%, while the worldwide rates came in at 90.5%. Both of these rates were up 0.1% from FQ4 2023 end of the quarter.

Looking at Gross Profit, it increased to 12.7% gross margin higher YoY by 45 bps. We can see the margin starting to return to the levels in 2021. As I calculate, we will see FY24 gross margin in the 12.5% levels.

As we spoke about in the previous articles, if you say Costco is not a good company based on the low Operating profit, it’s a sign that you don’t know the company. Costco’s operating margin is not the main goal of the company, Costco has a clear business of providing value to its customers as its main goal. As a result, we see a lower margin. In the first quarter of fiscal 2024, the operating margin increased by 21 bps or 0.21% YoY.

Looking at Net income for the quarter, it was $1,589 billion, $3.58 per diluted share, compared to $1,364 billion, $3.07 per diluted share, last year. This year’s results included a tax benefit of $44 billion, $0.10 per diluted share, while Net income was up 16.5% YoY in the quarter.

Transaction Data

The average transaction was down 0.9% worldwide and down 1.6% in the U.S. foreign currencies relative to the U.S. dollar positively impacted sales by approximately 0.4%.

Warehouse Expansion

In the first quarter, Costco opened 10 locations, including one relocation, so a net of nine increases. Those nine included eight in the U.S. and one in Canada.

For FY 24, Costco is planning to open 33 locations, including two relocations, so far a net boost of 31 new warehouses. That would be up from the 23 that they opened in fiscal ’23. For Q2 2024, Costco plans four new locations, including a sixth building in China.

As a result of the expanding location calculate, Costco estimates the Capex of Fiscal ’24 will be $4.4 billion to $4.6 billion, which is up from $4.3 billion, reflecting a continued boost in the number of warehouse expansions.

E-commerce

In terms of e-commerce business, e-commerce sales in Q1 ex-FX increased 6.1%, the first quarterly YoY boost in five fiscal quarters, and trended well during the three reporting periods of September, October, and November. E-comm showed strength in several areas.

Important Note

The best news that Costco provided to its investors was the $15.00 special dividend.

Costco has extremely Sbc Adj. Free cash flow, or FCF, has allowed them to pamper their investors with the special dividend, which they haven’t done since December 2020, when they gave a $10 dividend. The huge advantage that Costco has is that it is a cash machine, which gives it the possibility, besides growing the business and doing buybacks, of providing a crazy dividend of $15 per share.

Valuation

I decided to value Costco differently from the first and the second articles because the first valuation didn’t change. I adopted an alternative valuation approach for Costco

I anticipate high-single-digit revenue growth for Costco in the coming years, driven by its warehouse expansion, comparable sales growth, and membership fees. This revenue growth is expected to be accompanied by similar growth in net profit, as the company benefits from improved operational efficiency and the positive impact of share buybacks on earnings per share (EPS). Plus, a Fwd dividend yield of 0.65%.

Costco has a long history of share buybacks, and I believe this trend will continue in the coming years. This commitment to shareholder value is a key factor in my investment thesis for Costco.

Based on my analysis, I believe Costco has the potential to deliver a low double-digit return over the next seven years. This is below the company’s historical performance. I am confident that Costco’s strong fundamentals and commitment to shareholder value will make it a rewarding investment for years to come.

Based on fiscal Q1 results and guidance, I calculate Costco’s fiscal Q2 revenue to be $60.4 billion, and I calculate FCF adj. stock-based compensation, or SBC, reached $2.4 billion.

Risks

Despite Costco’s impressive performance, several risks could hinder future growth and investor returns:

1. Heavy Reliance on Membership Fees: Costco’s business model heavily relies on membership fees, making it vulnerable to economic downturns and changing consumer preferences. If membership renewal rates reject or new member acquisition slows, it could significantly impact revenue and profitability.

2. Saturation and Competition: With its rapid expansion, Costco might reach saturation in certain markets, limiting future growth potential. Additionally, competition from online retailers and discount stores could put pressure on prices and margins.

3. Supply Chain Disruptions: Costco relies on a complex global supply chain, making it susceptible to disruptions caused by geopolitical events, natural disasters, or labor shortages. These disruptions could direct to product shortages, higher costs, and ultimately, customer dissatisfaction.

4. E-commerce Challenges: While Costco’s e-commerce business is growing, it still lags behind traditional retailers. The company needs to invest heavily in online infrastructure and marketing to contend effectively in this critical segment.

5. Dependence on Key Executives: Costco’s success is heavily reliant on the vision and leadership of its executives. Any unexpected leadership changes or succession issues could create uncertainty and potentially impact performance.

Overall, while Costco remains a strong company with a loyal customer base and robust financial performance, investors should carefully consider these potential risks before making investment decisions.

Conclusion

Costco’s relentless growth and unwavering commitment to providing value continue to impress. Its robust financials, loyal membership base, and strategic expansion plans paint a promising picture for the future. However, potential risks admire reliance on membership fees, market saturation, and supply chain disruptions cannot be ignored.

For long-term investors who value stability and consistent returns, Costco Wholesale Corporation shares remain a compelling option. However, it’s crucial to confess the risks involved and ensure your portfolio has adequate diversification. Ultimately, the decision to invest in Costco depends on your individual risk tolerance and investment goals.

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