Costco‘s (NASDAQ: COST) stock recently set a new high after the company posted solid fiscal third-quarter earnings results. The warehouse giant shrugged off negative trends in the retailing industry to manage accelerating sales and profit gains. Its switch to a new co-branded credit card, meanwhile, is delivering major benefits by lowering Costco’s expenses and by boosting average customer spending.
Below, we’ll look at a few trends that could keep the retailer’s shares moving higher even though Wall Street already has an optimistic reading on this business.
Image source: Getty Images.
Customer traffic surprise
Customer traffic disappointed last year. Sure, Costco still managed growth in this key metric, but the rate of gains slipped from the stellar 4% pace the retailer had enjoyed for six straight years. That weakness helped comparable store sales growth fall to 4% from 6% or better in each of the last five years.
Sales growth excluding gas and foreign exchange. Chart by author.
It’s likely that the rising preference of shoppers for online purchasing over traditional retailing trips played a role in that decline. The bigger contributor was Costco’s credit card switchover, though, which suggests a quicker recovery. The shift to a new branded card paused membership signups and led to a rare drop in renewal rates that could reverse itself in the coming quarters.
There are hopeful signs of a rebound already, given that customer traffic growth improved to 3% last quarter from 2% in the prior quarter. Costco might not return to the heady 4% pace it enjoyed as recently as fiscal 2015. But even a small increase would push its comps further into market-thumping territory.
Maturing stores
Costco opened 29 new warehouses in 2016 — just one store shy of its record expansion year, 2014. These new locations carry huge initial costs and make up the biggest component of the company’s nearly $3 billion of annual capital expenditures. But they also are the best long-term bets that Costco can make on its overall growth. And those investments tend to pay bigger dividends over time.
Data source: Costco annual report.
The above chart is from Costco’s annual report and shows the average revenue per warehouse, in groups based on the year stores were opened. As you can see from the far-right column, the newest stores began their lives generating less than $90 million of sales. As they mature, though, warehouses contribute far more than that to the sales base. Locations that were 5 years old last year averaged $139 million of annual sales, and the figure rises to $174 million for those that have been open for 10 or more years.
Costco is on track to open 26 new locations in fiscal 2017. If management continues its aggressive expansion pace, investors should see the benefits snowball over the coming years.
Pivoting on cash returns
Finally, Costco’s stock could jump if the management team decides to boost its dividend. It has plenty of room to make that move, after all. Dividends account for just 33% of trailing earnings, which is far less than the broader market average of 50%.
Costco has supplemented that weak payout with massive special dividends over the last few years, including a $7-per-share bonanza this past quarter. The company issued a similarly sized special dividend in 2013 and a $5-per-share payout in 2015.
But while those returns are nice to see, shareholders can’t count on them since the company is just committed to a quarterly dividend that equates to a 1% yield.
In my view, it’s time that Costco’s dividend policy reflect the fact that its earnings are more predictable than those of peers, not less. By boosting its payout the retailer could signal a healthy dividend commitment that would make the stock more attractive to income investors.
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