Membership Fees, Costco Wholesale Corporation (COST)’s Main USP: Wal-Mart Stores, Inc. (WMT), Target Corporation (TGT)

1Q13 Results

1Q13 sales increased 9.6% y-o-y with Comparable Same Store Sales (SSS) of +7% for the quarter and SSS, excluding gas and FX, of 6%. Gross margins were increased by 6bps to 10.68% (up 12 bps without gas inflation). Merchandise margins, down 1 bps, continue to be in negative territory, but compare favorably to the previous four quarters when the y-o-y core merchandising gross margin variances had ranged from -10 to -16 basis points. Operating profit increased 18%, while margins were up 25bps to 2.7% mainly due to lower selling, general and administrative expenses partially offset by higher pre-opening expenses due to its expansion plans.

Furthermore, for FY13, Costco guided $2 billion of capital expenditure, higher than the FY12 capital expenditure of $1.5 billion due to higher penetration of the number units planned in Asia and anticipated higher ramp of total openings schedule (plans to open 30 new stores, twice as many as last year).

Versus Competitors

Costco’s 1Q13 results outperformed its competitors Wal-Mart and Target. While Wal-Mart reported SSS of +3.8%, Costco reported SSS of +7%. Segment operating income for Costco also grew 18%, compared to Sam’s Club’s operating income increase of 12.7%. Similarly, Target Corporation (NYSE:TGT) reported 0.4% SSS, and operation profit increased 3.2%.

Further, Costco and Wal-Mart Stores, Inc. (NYSE:WMT) announced dividends in December 2012 in order to save shareholders from increased taxes. While Wal-Mart announced an accelerated dividend, Costco announced a special dividend of $7 per share over its regular dividend of $ 0.275. Costco’s special dividend was financed by additional debt of $3.5 billion. One may argue about whether Costco took the right decision in announcing special dividends or should have rather re-invested the cash flows back into the business. On the other hand, the majority of Wal-Mart’s dividends will go to the Walton family, who still own 51% of shares, whereas in Costco there is no such majority.

Costco loses its competitive advantage on the dividend front. While Wal-Mart Stores, Inc. (NYSE:WMT) has given its investors a dividend yield of 2.2% with a payout ratio of 32% and Target Corporation (NYSE:TGT) has a dividend yield of 2.1% with a payout ratio of 29%, Costco lags behind with a yield of 0.5% and payout of 26%. (Source: Yahoo! Finance)

Conclusion

Costco Wholesale Corporation (NASDAQ:COST) is one of those stocks which investors feel good about due to their strong membership and given that they are low cost provider in a huge market. To back it they have a history of buying back shares, increasing the dividend, and growing earnings. Future catalysts for its share prices include new store openings, continued membership retention, modest share buybacks, and consistent operating margins. However, investors should keep a watch on its membership fees and retention rates. If the raising of membership fees causes its retention rates to fall below its historic level of 85%, it may be a warning sign that its business model is weakening against its competitors.

The article Membership Fees, Costco’s Main USP originally appeared on Fool.com.

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