Costco Wholesale Corporation (NASDAQ:COST) Q2 2023 Earnings Call Transcript

Costco Wholesale Corporation (NASDAQ:COST) Q2 2023 Earnings Call Transcript March 2, 2023

Operator: Good day. My name is Emma, and I will be your conference operator today. At this time, I would like to welcome everyone to the Costco Wholesale Second Quarter Fiscal Year 2023 Earnings Conference call. Richard Galanti, CFO, you may begin your conference.

Richard Galanti: Thank you, Emma, and good afternoon to everyone. I will start by stating that these discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements. The risks and uncertainties include, but are not limited to, those outlined in today’s call as well as other risks identified from time to time in the company’s public statements and reports filed with the SEC. Forward-looking statements speak only as of the date they are being made, and the company does not undertake to update these statements except as required by law.

In today’s press release, we reported operating results for the second quarter of fiscal ’23, the 12 weeks ended this past February 12, as well as February retail sales for the 4 weeks ended this past Sunday, February 26. Reported net income for the quarter came in at $1.466 billion or $3.30 per share compared to $1.299 billion or $2.92 per diluted share last year, an increase of 13%. In terms of sales, net sales for the second quarter increased 6.5% to $54.24 billion compared to $50.94 billion reported a year ago in the second quarter. Our comparable sales for the second quarter were as follows: in the U.S., 5.7% for the 12-week period, excluding gas inflation, 5.8%; Canada, 3.5% reported and 9.6% excluding gas inflation and FX; Other International, 3.8% reported and 9.5% ex gas inflation and FX; for Total Company, 5.2% reported and 6.8% excluding gas inflation and FX; e-commerce was minus 9.6% for the 12 weeks reported and minus 8.7% excluding FX.

In terms of second quarter comp sales metrics, traffic or shopping frequency increased 5% worldwide and 3.7% in the United States. Our average transaction or ticket was up 0.2% worldwide and up 1.9% in the U.S. during Q2. Foreign currencies relative to the dollar negatively impacted sales by approximately 1.8%, and gasoline price inflation positively impacted sales very slightly by approximately 0.2%. I’ll review our February sales results later in the call. Next on the income statement is membership fee income. Reported in the second quarter, $1.027 billion of membership fee income or 1.89%. That’s for this year’s second quarter compared to $967 million a year earlier, so a $60 million increase in dollars or up 6.2%. Excluding the headwinds in FX, the $60 million increase would have been higher by additional $20 million.

So on an FX-adjusted basis, membership fee income was up just over 8 percentage points. In terms of renewal rates, at second quarter end, our U.S. and Canada renewal rate was 92.6%, up 0.01% from Q1 end, and worldwide rate came in at 90.5%, also up 0.01% from the prior quarter, both represent all-time highs. Membership growth has remained strong. We ended the second quarter with 68.1 million paid household members and 123.0 million cardholders, both up more than 7% versus a year earlier. At Q2 end, we had 30.6 million paid executive memberships. This is an increase during the 12-week quarter of 630,000 members since Q1 end. Executive members now represent 45% of paid members and about 73% of worldwide sales. Moving down the income statement, next is our gross margin.

On a reported basis, gross margin was higher year-over-year by 8 basis points, coming in at 10.72% as a percent of sales as compared to a year earlier second quarter at 10.64%. Now the 8 basis points up, and then excluding gas inflation, have been up 9 basis points. As I always ask you to draw a little chart with 2 columns, reported and excluding gas inflation, and then we’ll go down the line items. Core merchandise was minus 6 basis points reported and also minus 6 ex gas inflation. Ancillary businesses were plus 2 and plus 3 basis points year-over-year; 2% reward, minus 2 and minus 2 basis points. LIFO, since we had a charge last year and nothing this fiscal quarter, it was plus 14 and plus 14. For total, again, reported, 8 basis points up year-over-year; and ex gas inflation, up 9 basis points.

Starting with the core. Our core merchandise gross margin again was lower by 6 basis points year-over-year. In terms of core margin on their own sales, our core-on-core margin, if you will, it was lower year-over-year by 26 basis points. Most major departments in general were down, with fresh foods being down a little more than others. We’re continuing to hold or drop prices where we can to drive traffic and improve our competitive advantage. Overall, core sales benefited from sales shifting from ancillary and other businesses to core. Ancillary and other businesses gross margins again were higher by 2 and 3 basis points ex gas in the quarter. Gas business centers and travel were better year-over-year, offset in part by e-com and pharmacy. 2% Reward lower by 2 basis points, that’s reflective of the higher sales penetration coming from our executive members.

LIFO, as I mentioned, was a year-over-year variance of plus 14 basis points. We had no LIFO charge this fiscal quarter compared to a $71 million charge in Q2 last year. Moving on to expenses, SG&A. Our reported SG&A for the second quarter was higher year-over-year by 13 basis points. This year, it was 9.11% compared to 8.98% in the second quarter of last fiscal year. Jotting down some numbers for the 2 columns, first column being reported; the second, ex gas inflation. Operations was down — higher, I said, minus 2 basis points — higher by 2 basis points, so minus 2 and minus 2; central, minus 9 and minus 9, so higher year-over-year in central by 9 basis points; stock compensation, minus 2 and minus 2; and then all told, that would be 13 basis points higher, both on a reported basis and ex gas inflation.

The core operations component of SG&A, again, higher by 2 basis points and also higher by 2 ex inflation. This includes the wage and benefits increases implemented last March and last year’s third fiscal quarter and an additional top-of-scale wage increase that went into effect July 4, which was in our fourth quarter of last year. Central, as I mentioned, was higher by 9 basis points year-over-year. About half of this increase is a charge related to a tax audit covering several prior years. Stock comp pretty much as expected, just a couple of basis points. Below the operating income line, interest expense was $34 million this year, $2 million lower than the $36 million figure in Q2 of last year. Interest income and other for the quarter was higher by $89 million year-over-year.

This was driven by an increase in interest income due to both higher interest rates being earned and on higher cash balances. The increase in interest income was slightly offset by unfavorable FX. In terms of income taxes, our tax rate in the second quarter was 26.1%, down slightly from the 26.7% figure in Q2 last year. The effective rate for the year, excluding discrete items, continues to be projected in the 26% to 27% range. Overall, net income was up about 13%. In terms of a few other items of note, warehouse expansion. In the second quarter, we opened 3 net new warehouses, 2 in the U.S. and 1 in Australia. Additionally, next week, we’ll open our third warehouse in China, with our fourth and fifth China new openings scheduled to open in the fourth quarter of this fiscal year, so a total of 3 this fiscal year in China.

In fiscal ’23, we expect to open a total of 27 warehouses, including 3 relocations, so a net increase of 24 new warehouses. These 24 planned new openings are made up of 14 in the U.S. and 10 in Other International. The 10 in Other International includes the 3 in China, along with our first Costcos in each of New Zealand and Sweden, both of which were opened during the fiscal first quarter. Regarding capital expenditures, our second quarter fiscal ’23 capital spend was approximately $900 million. Our estimate for the year remains in the range of $3.8 billion to $4.2 billion based on timing. In terms of e-commerce, as I mentioned, e-commerce sales in Q2, ex FX decreased 8.7%. This weakness was driven mostly by our online mix of sales. Big-ticket discretionary departments like majors, home furnishings, small electrics, jewelry, hardware, these were down 15% in the quarter and make up 58% of our e-com sales.

These same departments, by the way, were down 11% in warehouse but only make up 8% of total warehouse in-line sales. Now a few comments regarding inflation. It continues to seem to improve somewhat. Recall, back in the fourth fiscal quarter, which ended last August, our estimated year-over-year price inflation was 8% for that prior fiscal year. During Q1, the estimate on a year-over-year basis came down to 6% to 7%. In Q2, we estimate that the equivalent year-over-year inflation number has come down to 5% to 6% range and even a little lower than that towards the end of the quarter, according to the buyers. We continue to see some improvements in many items. Commodity prices are starting to fall not back to pre-COVID levels and some examples but continue to provide some relief with things like chicken, bacon, butter, steel, resin, nuts.

Switching over to our inventory levels. Again, both in Q3 and Q4 fiscal year-ends in fiscal ’22, on a year-over-year basis, our inventories were up 26% year-over-year. And then in our first quarter of this year, they were up 10%, so good improvement there. As of this quarter end, our inventory year-over-year as of the end of Q2 was down 2% year-over-year. Regarding the 2% drop, we were a bit over-inventoried last year as a result of supply chain challenges, causing inventory to be backed up at the ports. And talking to the buyers a year ago, their estimate of just timing of getting things across the ocean was 70-plus days. Today, it’s back down to 30-ish days. And so supply chain improvement across the board and rates, of course, coming down.

Now turning now to our February sales, the 4 weeks ended this past Sunday, February 26. As reported in our release, net sales for the month were $17.06 billion, an increase of 4.7% from $16.29 billion a year earlier in the month of February. Recall from January sales results that the Lunar New Year, Chinese New Year occurred on January 22 this year, 10 days earlier this year. The shift positively impacted February’s Other International by about 2% and Total Company by about 0.25%. Additionally, February’s results for both the U.S. and Total Company were negatively impacted by approximately 1%, we estimate, as a result of substantially worse weather this year over year. I believe most of that was on the traffic side rather than ticket side. Same-store sales, again in the release, on the U.S., as reported, 3.4%; ex gas, 3.5%; Canada reported, 1.2; ex gas and FX, 7.3%; Other International, 6.5% reported; ex gas and FX, plus 11.5%; Total Company, 3.5% reported; ex-gas and FX was 5.0%; in terms of e-com, minus 11.2% reported compared to a minus 10.3% without FX.

That’s actually an improvement from our January e-com results. Our comp traffic or frequency in February was up 4.9% worldwide and 3.1% in the U.S. Foreign currencies year-over-year relative to the dollar negatively impacted total and comparable sales as follows: Canada, been impacted by 5.5 percentage points, Other International by approximately 5.7% and Total Company by approximately 1.5%. Gasoline prices were essentially flat year-over-year, ever so slightly inflationary, but essentially flat. Worldwide, the average transaction for February was down 1.3%, including the negative impact from FX that I just mentioned. In terms of regional and merchandising categories, general highlights for February that we normally do in this monthly sales call.

The U.S. regions with the strongest comp sales were the Midwest, the Northeast and the Southeast. In terms of Other International, in local currencies, we saw the strongest results in Spain, U.K. and Mexico. Year-over-year inflation for food and sundries and fresh foods, while still elevated, were at their lowest levels in nearly a year, with food and sundries inflation dropping to the high single digits and fresh foods to the low to mid-single digits. Moving to merchandise highlights. The following comparable sales results by category for the month excludes the negative impact from foreign exchange. Food and sundries were positive low double digits. Cooler, food and sundries were the strongest. Fresh foods were up mid-single digits. Better-performing departments included bakery and meat.

Non-foods were negative mid-single digits. Better-performing departments included tires, health and beauty aids and apparel. Majors, which were electronics and big-ticket electronics items, jewelry, housewares, domestics and small appliances and hardware were the worse performers, consistent with Q2 overall. Ancillary businesses sales were up mid-single digits. Food court, hearing aid and pharmacy were the top performers there. Finally, in terms of upcoming earnings and sales releases, we will announce our March sales results for the 5 weeks ending Sunday, April 2, on the following Wednesday, April 5, after market close. And with that, I’m happy to turn it back over to Emma for questions and answers. Thank you.

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Q&A Session

Operator: Your first question today comes from the line of Simeon Gutman with Morgan Stanley.

Simeon Gutman: I guess, sizing up the consumer, I want to see how you view February in, I guess, the continuum of months. And then part of it, I think you said down mid-teens with some of those e-commerce categories. Thanks for that information. Is that stable? Is that worse? How do you kind of diagnose the whole consumer in the business?

Richard Galanti: Well, I think as we talked about even the last 12 weeks ago, in the quarterly numbers, we’ve seen some weakness in what I’ll call big-ticket discretionary items. I’m not an economist, but I think it’s a combination of the economy and concerns out there as well as particularly strong numbers that we enjoyed not only a year ago but a year prior to that with COVID that we, of course, benefited in big ways with those big-ticket items. So all those things, I think, reflect that in those numbers. There’s just a couple of weeks in a couple of regions where we started to set out some seasonal things for spring and summer. So far, so good, but it’s literally small data points in small parts of the country where the weather has been a little better, which is not a lot of places.

But anecdotally, some comments were made on things like even some water sports items and camping equipment. But it’s a small data set. So we’ll cross our fingers and hope to see. But overall, units are generally fine. I mean there’s some things still with like, on the computer side, there’s weakness overall, not just with us. I think I mentioned this on the first quarter call, we’re seeing decent sales in units of televisions while the average selling price points have come down. I think it’s just in the next couple of weeks where the new TVs for the upcoming season are coming out. But other than that, what we look at, of course, our average transactions or shopping frequency is up. Our new sign-ups are continuing to be strong, up 7% in terms of new sign-ups on less than 3% new openings.

So those things bode well, but people certainly are spending their dollars where they feel they should be spending them. And so we’ll see where it goes from here.

Simeon Gutman: Okay. A follow-up on EBIT growth, I know you don’t guide, but this business has averaged, I think, about high single or maybe around 10% over time. This year, it’s a little below average because of some of the lapping and you are lapping some great fuel gross profit. Curious of the puts and the takes. So whatever number that you expect the EBIT dollars of this business to grow, are you confident in the levers that you have to get there?

Richard Galanti: Well, look, we feel good about what we’re doing in driving business in the right way and growing our business. As you and others have heard forever, we’re a top line company. While I can’t give guidance, certainly, we and everybody who has cash benefit from earning more money on their cash right now. As we saw in this quarter, there was a $70 million improvement in year-over-year comparison of gross margin simply because of LIFO. We can’t predict what’s going to happen, at least the trends yesterday were that we’re starting to see some improvement in inflation. To the extent that continues, we’re comparing to LIFO charges in excess of $100 million and $200 million in each of Q3 and Q4. So that’s something that we look at as well.