Costco's Earnings Miss Is Almost All About Gas

The global health crisis has changed consumer preferences with shoppers spending more on essential items such as food and home goods along with buying more online, both of which benefited Costco Wholesale Corporation COST over the past year. However, the warehouse club titan's earnings growth came crashing to a virtual halt last quarter. Last week, the warehouse club giant reported that its sales momentum remained strong last quarter but the earnings miss led its shares to surrender all of their gains of the past 12 months. However, investors shouldn't worry too much as the company's long-term earnings growth trajectory remains intact.

The Q2 FY 2021

The three-month period that ended on February 14^th 2021, the retailer saw strong sales but disappointing earnings. Costco has continued to report strong sales growth in recent months, including an impressive 15.7% increase in adjusted comparable sales during January. During the latest quarter, comparable sales rose 13% YoY and net sales grew 14.7% to $43.9 billion.

But Costco's net margin weakened from last year's 2.42% to 2.17% a year earlier and managed to offset the increase in sales and earnings per share increased just 2% YoY, from $2.10 to $2.14, which was below expectations of $2.45.

The retail giant had substantial COVID-19-related costs, including the $2/hour wage premium it began paying a year ago that reduced its EPS by about $0.41 this time around. But this cost didn't stop EPS from jumping 32% in the prior quarter, the first quarter of fiscal 2021.

Gasoline Is A Big Business

What drove the drop in profitability were the lower margins on gasoline sales. Gross margin in its core categories increased YoY but overall gross margin decreased because gasoline margins weakened significantly over the quarter. Gasoline produces volatile profits. In the recent months, gasoline costs rose and Costco was deliberately slow to raise its prices to foster customer loyalty and drive traffic to its gas stations and, by extension, its warehouses. However, this strategy comes at the cost of profitability. Conversely, when gasoline prices are falling, Costco tends to earn higher margins from its gas business and the recent rally in gasoline prices should peter out soon, so Costco's profitability from this segment will improve in the near term.

Profitability Should Improve

Costco tends to raise membership fees every five or six years, and the last increase took place in June 2017 so the next one should come within a year or two. Membership fees make up a bulk of the warehouse club's profits, so any increase should drive a significant increase in earnings.

Outlook

Costco is likely to continue gaining market share as it capitalizes on its growing member base and its new delivery capabilities for bulky goods like appliances and mattresses. Additionally, it will benefit from smaller retailers being forced to close shop as many don't have the resources to survive the pandemic and await the aftermath. The latest earnings miss doesn't change the fact that Costco has been a big winner as the COVID-19 pandemic reshaped the retail landscape and consequent events should drive increases in its top and bottom lines.

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