Costco Shrinking Margins Weaken Profit Beat, Stock Drops

Costco Wholesale posted a profit for its recently ended quarter that barely beat Wall Street expectations helped by an increase in fees for membership, but a drop in its gross margins, sparked concerns of deeper price wars in the grocery industry, which helped drag down its share price by 3.6% in trading after hours on Thursday.

Investors are worried that the company’s business model that generates most its revenue through its niche membership club will face much more competition from Amazon.com, which has started to shake up the grocery industry after acquiring Whole Foods.

Gross margins during Costco’s fiscal fourth quarter were down 15 basis points year to year, as the retailer increased spending to drive its sales and create more member loyalty.

Industry analysts on Wall Street said they believe that sentiment for the short term and fear of the impact in the long term of Amazon on the business of Costco could continue to pressure shares and limit its valuation upside.

Shares of Costco have dropped 7.2% since an announcement was made in June by Amazon that it acquired Whole Foods.

Costco implemented its membership fee hike again this quarter, raising prices of membership between $5 and $60 for its Goldstar and business members, and between $10 and $120 for its executive memberships.

Costco’s membership fees represented close to 72% of its operating income during 2016, increased 13% during its 17-week fiscal fourth quarter that ended on September 3.

Excluding an impact for currency fluctuations and fuel, total comparable sales were up 5.7%, while Wall Street was expecting a 5.1% increase. Costco’s comp sales in the U.S. increased during the quarter by 5.8%.

Net income that was attributable to Costco increased to just over $919 million equal to $2.08 a share compared to last year during the same period of $779 million equal to $1.77 a share.

Costco’s total revenue ended at $42.3 billion an increase of 15.7%. Analysts were expecting earnings to be $2.02 a share on revenue of $41.54 billion.

Costco announced that it started two new delivery services for groceries this week, a big step in efforts to battle the growing competition in delivery services from Walmart and Amazon.

A two-day delivery service for dry groceries along with a same-day service for groceries that includes fresh foods was implemented by Costco. The two-day service is free for orders online that exceed $75 in the U.S, while the same-day service is offered in its U.S. stores through Instacart.

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