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5 Things Costco Wholesale Corporation's Management Wants You to Know


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Last week, Costco Wholesale Corporation reported solid results for Q4 of its 2014 fiscal year. Mr. Market was very pleased, sending Costco shares to a new all-time high even as the rest of Wall Street struggled.

COST Chart

Costco Wholesale Corporation 5 Year Stock Chart, data by YCharts

On Wednesday morning, longtime Costco CFO Richard Galanti spoke to analysts and investors about the company's Q4 earnings. Based on his comments, shareholders can be confident that Costco is well-positioned to keep delivering above-market investment returns.

Underlying results were even better

Overall, $1.58 earnings figure for the year's fourth quarter was reached despite several discrete items, representing $0.05 or $0.06 [per share] in the aggregate that did not go our way.
-- Richard Galanti, Costco CFO 

Costco grew EPS 13% in Q4 to $1.58. This was a big turnaround from its recent trend; through the first three quarters of FY14, Costco's adjusted EPS had declined slightly year-over-year. In fact, the news was even better than it seemed.

A number of small, unusual items combined to depress Costco's EPS by $0.05 or $0.06 last quarter. The headwinds included unfavorable currency fluctuations, changes in inventory valuation, a higher effective tax rate, and higher bonus accruals. These were somewhat offset by higher profits from high-volume, low-margin gasoline sales.

Costco's earnings growth could have been even higher last quarter (Photo: The Motley Fool)

For the most part, these factors depressing Costco's earnings were either one-time or short-term in nature. This means that if Costco's underlying business trends remain the same in the next few quarters (and years), it will report even stronger earnings growth.

Looking for more millenials

In early September ... for 8 days, we ran a nationwide membership promotion for new members on LivingSocial. These types of promotions, we believe, will allow us to get in front of younger demographics.
-- Richard Galanti, Costco CFO

One of Costco's biggest potential weaknesses is its aging customer base, which skews heavily toward baby boomers. Costco has been trying a variety of tactics in order to gain younger members. It hopes to convert these new customers into loyal long-term Costco shoppers.

In March, Galanti talked about expanding Costco's organic selection to appeal to millenials. This is a big opportunity because organic items tend to have higher markups at other retailers, allowing Costco to offer significant savings.

Costco recently ran a LivingSocial promotion that threw in several free items including a giant toilet paper package (Photo: The Motley Fool)

The most recent tactic was a LivingSocial deal. For $55 (the regular cost of a membership), people who signed up also got a $20 cash card, a rotisserie chicken, an apple pie, and a package of Kirkland Signature toilet paper, plus some other offers. In other words, the LivingSocial deal provided a whole lot of extra value, making the effective cost of the membership close to $0.

Since LivingSocial users tend to be younger, this offer is bringing in millenials who otherwise might not have joined Costco. Even if the renewal rate is significantly below 90% -- Costco's recent renewal rate in the U.S. and Canada -- this move will still generate significant long-term value, since the new customers are much younger than Costco's average member.

Plenty of growth opportunities

For the current fiscal year, fiscal year '15, our plans are to open 31 new warehouses and also relocate 4 existing locations. 19 of the planned 31 new locations will be in the United States, with the remaining in international markets.
-- Richard Galanti, Costco CFO

Galanti also provided an update on Costco's expansion plans. During FY14, Costco increased its warehouse count by 29. For FY15, the company has 31 new warehouses planned. That said, the openings are heavily weighted toward the back half of the fiscal year, with 21 scheduled in Q4. A few of those planned openings are likely to slip to FY16.

Regardless of the exact total of warehouse openings, Costco is likely to end the new fiscal year with roughly 4% square footage growth: in line with the recent trend. Most importantly, the company has a long pipeline of growth opportunities. Costco is likely to open an average of 30-35 new warehouses annually for the foreseeable future.

E-commerce is profitable and growing

Sales in e-commerce were up in the high teens for both the fourth quarter and the fiscal year.
-- Richard Galanti, Costco CFO

E-commerce is another area with significant growth potential for Costco. Last year, Costco's e-commerce sales totaled just under $3 billion: less than 3% of total sales. E-commerce is actually more profitable than Costco's core warehouse business.

Fortunately, Costco's e-commerce sales have been growing at an 18%-19% annual rate recently. That's more than double the company's overall growth rate. As e-commerce sales grow to represent a larger proportion of total sales, Costco's profit margin should rise.

Costco is trying out a few strategies to drive e-commerce growth. One tool is simply expanding to new countries. Costco only operates e-commerce sites in the U.S., U.K., Canada, and Mexico today. However, it has warehouses in several other countries, including Japan, South Korea, and Australia. Costco plans to add 1-2 countries to its e-commerce operations in the upcoming year.

Costco has partnered with Google to boost e-commerce growth (Photo: The Motley Fool)

Costco has also partnered with Google through the latter's Google Shopping Express platform, which provides same-day delivery from a variety of retailers. Google Shopping Express began in the Bay Area and has since expanded to Manhattan and West Los Angeles. If Google continues to grow the program, it should help Costco grow significantly in e-commerce.

Bringing home some cash

[Costco will] repatriate from Canada back to United States about USD 1.2 billion or CAD 1.3 billion of our Canadian cash ... balances in the near future.
-- Richard Galanti, Costco CFO

Like many U.S. corporations, Costco has a significant amount of overseas cash. As of August, 2013, Costco had more than $2.3 billion held outside the U.S. Costco recently decided to repatriate a large chunk of that money from Canada because its annual earnings there are more than enough to pay for future growth investments.

Repatriating cash to the U.S. can often lead to steep tax bills -- which is why many corporations hold so much money overseas. However, Costco will only pay $15 million in taxes to repatriate this sum of money.

This is a great move for shareholders. It will give Costco significantly more flexibility to repurchase more shares while continuing to raise its dividend each year.

Strong momentum

Costco's Q4 earnings demonstrate that the company is firing on all cylinders. Costco remains a solid long-term investment opportunity due to its steady high single-digit growth rate and consistent profitability. Foolish investors would be wise to take a closer look at this strong brand-name company in order to see if it has a place in their investment portfolios. As always Foolish investors should do their own research before making any investment decisions. 

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The article 5 Things Costco Wholesale Corporation's Management Wants You to Know originally appeared on Fool.com.

Adam Levine-Weinberg owns shares of Costco Wholesale. The Motley Fool recommends Costco Wholesale, Google (A shares), and Google (C shares). The Motley Fool owns shares of Costco Wholesale, Google (A shares), and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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