Even More Reasons to Buy Costco Wholesale Corporation (COST)

Page 1 of 2

It’s been a good earnings season for the high-end brands. Michael Kors, Saks, and Tiffany have all made waves, managing to avoid the slowdown that came with cold weather in the beginning of the year. On the bulk side, it’s been a different story. Wal-Mart Stores, Inc. (NYSE:WMT) and Target Corporation (NYSE:TGT) both failed to impress, with the companies blaming weather and tighter purse strings for their woes. Luckily, one brand rose above the chatter to make real progress — unsurprisingly, it was Costco Wholesale Corporation (NASDAQ:COST).

The retailer had a jump in comparable sales, a good push in membership fees, and beat analyst estimates for earnings per share. The real key is that second point — growing its customer base. Because Costco relies on fee-paying customers, it has to keep growing that base and keeping the masses happy. So far, it’s been a good year on all fronts.

Adding buyers to grow the business
Over the first two quarters this year, Costco Wholesale Corporation (NASDAQ:COST) grew its membership base by 1.6 million people. Through those quarters, North American members were renewing at a rate of almost 90%. That’s one of the most important numbers in Costco’s reporting, because it shows investors just how happy consumers are with this brand.

Costco Wholesale Corporation (COST)Over the third quarter, fees from memberships rose 12%, which helped push overall earnings per share up from $0.88 a year ago to $1.04 this year — analysts were looking for $1.03. The membership fees are like gold dust, for investors and the business. Not only do the fees renew at that 90% rate, they also have a low cost basis. Over the last quarter, that low cost helped Costco Wholesale Corporation (NASDAQ:COST) increase operating margin from 2.8% in fiscal 2012 to 3% this year.

The growth of membership is what has kept Costco out in front of Wal-Mart Stores, Inc. (NYSE:WMT) and Target Corporation (NYSE:TGT). Both of those companies rely on two combining factors to grow their businesses. First, customers have to be price-conscious enough to want to shop at a discounter. Then, the companies have to be the best place for those buyers to shop. While Target has made strides with its in-house brands, it still relies on low prices to get the job done.

The beauty of membership
Costco Wholesale Corporation (NASDAQ:COST)’s membership program sidesteps the second part of that equation. By making people pay for a membership, it becomes their default shopping location for many items. Even if it doesn’t have the absolute lowest price, it doesn’t matter because members are predisposed to shop there.

Costco Wholesale Corporation (NASDAQ:COST)’s membership system basically takes advantage of our human nature to act irrationally in the face of sunk costs. We spend $100 on a pool membership and then berate ourselves every weekend that we don’t go, even though no amount of going will get us $100 back. So, too, Costco members will buy from Costco even when it doesn’t make the most sense, since they already put money into that darn membership.

Page 1 of 2