Costco FY 3Q17 Earnings Call Notes

Richard Galanti

8% sales increase

“Turning to our third quarter sales, reported sales were up 8% and our 12 week total company reported comparable sales figure was up 5%. For the quarter, the plus five comp sales figure was helped by gasoline price inflation to the tune of about 140 basis points and offset or hurt from FX by about minus 60 basis points.”

A little inflation is good

“Well I think for low margin retailers and certainly we are at the low end and the lowest end of margins, but super market is well on the food side, a little inflation is good, a little deflation hurts you a little bit it still has the D in front of it, not the IN and so it’s still impacting some. it hurts you most in items like I think the example I gave last quarter was of fresh meats where year-over-year, second quarter or first quarter year-over-year per pound beef was down by 10% and we were selling more than 10% more tonnage and certainly we are having lower gross margin dollars because of that and so as that changes that will help us a little bit.”

*Being the low cost operator means not advertising

“Sure. And I think first if the advertise is good, we don’t advertise we don’t spend on that and we would love seeing add TV and the print adds still from both other competitors. And we are not concerned about it. We think that the value of the Costco is still as significantly higher price or without the free three months is a much better value. And we think that’s evidence by our success of what we have done overtime and the fact that even what we have done in the past renewal rates have not really been impacted by it.”

Costco FY 2Q17 Earnings Call Notes

Richard Galanti

Still seeing deflation

“Regarding deflation, overall, primarily in the US, we have seen deflation in the 1%, 1.5% range in February. Departments such as foods, sundries, frozen foods, liquor meat, dairy showed the most deflation on the foods and sundries side. On the non-food side consumer electronics continue to be deflationary, primarily in the TV category. In terms of new openings, our opening activities, we planned, we opened a net of a 8 new locations during the first quarter, nine less were re-low.”

Working with instacart and Google Express

“Finally, a quick update on other home and office delivery sales channels. As you know, we partner with Google Express in five cities, operating out of 15 of our Costco US warehouses. In addition, we’re working with Google Express on a new service offering one to three day shipping of products throughout the Continental United States. We also continue to work with Instacart. Instacart currently operates in 26 US cities, in our case utilizing 132 of our US locations, and we are either testing or getting ready to test two other third-party delivery services within the next month or so.”

Gas prices up 29% y/y

“As Bob is reminding me, and getting back to the gasoline comment, a lot of it has to do with the contribution penetration of these areas. With gas inflation – I think gas prices are up 29% over the year, and gallon comps were up higher as well because of that.”

Private label philosophy

“Sure. I think yes, but we also, our success has been based first by selling branded goods at the best value out there. Two reasons, one such sharp savings relative to everybody else and two, our KS – if it’s as good as, if not better quality, which is our starting point and even a greater savings versus what we sell the brand for, that’s even better. And it keeps our members happy and it keeps us and our vendors honest. We’ll continue to drive it. Recognizing there aren’t a lot of $300 million and $500 million items out there, like the waters and the paper goods, and the K cups and whatever. But there’s lots of $20 million and $30 million and $50 million items – we get surprised every day. So yes, there will be a continued push for that, but there’s also a continued push to add brands that historically haven’t been prepared to sell us.”

We’re a bit of a tortoise

” One of the things we all know, we have the best prices on great quality items. And we’ve never been too good about worrying about how to get it to that end customer a day earlier. We’re doing – it’s the 80/20 with us. We’ve done just in the last six or eight months, a lot of improvement online in that customer experience, with the smallest amount of effort. The low hanging fruit. We’ve got good things working on, but we’re doing these things, honestly, from our offensive standpoint not a defensive standpoint. And I’m not trying to be cute. Clearly we want to do it for competitive reasons, too, but it’s not like we looked at this and we lost. We see our renewal rates, ex-some of that auto bill stuff that we believe. We see our traffic going up still, and we see online, we see our page views and the like going up as well. With some of the additional items and the types of items we put on and better communication to our members of what that is. I think again, sometimes we’re viewed as the tortoise, not the hare. Certainly, over time we’re viewed as being stubborn. I think in my view, we’re a lot less stubborn and – but we’re still a little bit of a tortoise sometimes and we got a lot of good things going on. We’ll see, but stay tuned.”

Inflationary in the months ahead

“The collective view is inflationary, or less deflationary, for the next few months and maybe a little inflationary, but it’s a crap shoot.”

Border adjusted tax is bad for consumers

“As it relates to the border adjustment tax, there’s clearly the people out there that want it and manufacturers that export a bunch of stuff and don’t import a lot of stuff and at the very other extreme retailers. Recognizing border adjustment tax is just one element of one version of the tax reform plan that’s been put forward out there. The probability of what’s going to happen and when it’s going to happen and how much of it’s going to happen, we don’t know. We don’t believe it’s good for consumers – it’s going to raise prices and ultimately, I read articles where some retailers, particularly apparel retailers, were 90%-plus of their merchandise is sourced overseas, well a 20% tax is a 20% tax. While retailers generally tend to historically be full corporate taxpayers, us in the mid-30s in the US probably a little higher than that, the total company effective rate. It’s going to hit it and so to go through, we personally don’t buy into the fact that it will be offset by a big rising dollar. We don’t know what’s going to happen with the retaliation out there by other countries, and we’ll see. But as a retailer, we definitely think that it’s bad, and we’re against it.”

Costco 1Q17 Earnings Call Notes

Costco Wholesale (COST) Q1 2017 Results

Richard Galanti – EVP and Chief Financial Officer

November has been choppy

“Well, again, we don’t know. We’ll have to wait and see ourselves. We are thrilled that the first few weeks have been good. And again, November, the four weeks of November was choppy frankly, particularly the week of the election. I think it was worse than a snowstorm in terms of nobody wanting to go out and buy stuff and that’s what I read about other retailers as well. And again, over the last few months it’s been a little choppy a little more in November and a little weaker and so at least, what we can tell you at this point is the first couple of weeks have been okay. And again, traffic has seemed to have stabilized until something changes there, who knows”

The last few months have been a little more deflationary

“So overall, I think the feeling has given that the last few months have been a little more deflationary. The view is that it’s another few months of that, but they all believe that it’s going to come back the other way and this is a lot of estimated semi-educated guesses among different departments.”

Average age of membership is coming down

“We recognize convenience is a value but there’s also some things that we can and can’t do. So I think that we’re looking at these things offensively not defensively at this point. I don’t think that I think we’re encouraged when we see the level of millennials if you will that are signing up and we see the average age of our membership coming down. Now you know it was just a couple years ago when the average U.S. Costco adult member was four plus years older than the population as a whole now it’s a little under two. And that’s without a lot of planning but it’s what we do and I think part of that’s the merchandise selection and our ability to change merchandise pretty quickly and certainly things like again organic standout in a big way.”

Costco (Cost) 16Q4 Earnings Call Notes

Richard Galanti – Executive Vice President and Chief Financial Officer

 

Rewards program is estimated to improve by 40-50% under Citi

“In terms of increased cash back rewards, the estimate is about a 40% to 50% improvement in the reward program, which is already previously a very good reward program to the members using the Citi Visa Anywhere card… In terms of improved cash back member rewards, our former card provided a 3% cash back on gas, 2% on restaurant and travel, and 1% everywhere else, including everywhere at Costco other than the gas. With the new CV’s Anywhere card 3% on gas now is 4%, 2% on restaurant and travel is now at 3% and probably the most significant rewards improvement in terms of the total bucket here is the previous 1% reward on all other Costco purchases doubled from the previous 1% cash back rewards now to 2%.”

 

80-90% of the Amex to Citi benefit will go back to the customers in the form of lower prices

“the best, simplest answer is that just like when we buy a physical product better lower we can buy whether it’s lower freight, greater purchasing power or greater production efficiencies or whatever we figure out with our supplier, we generally wanted 80% or 90% of that, the vast majority of it given back to the customer in terms of lower price because that’s what drives us and drives our business… That will drive value to that member and loyalty to us and also more business to us. And secondly, what’s left over and when we originally did it, we did it such that we are going to keep a small amount of it.”

 

Food and tobacco deflation and other deflation may continue at current levels for a few months. No guess on gas

“I would say probably best guess is five months or six months of continued deflation at these newer levels in some cases. Gas, who the heck knows… Late fall, so it’s a few months. That sounds like a definite maybe.”

 

Foreign stores may have started slow, but they have picked up

“And as we have said, the one market that has been – we start, we remind ourselves that there is a time when we were going to close Korea and Taiwan and they are our most and almost our most profitable productive countries and locations. And we have talked about our first unit in Syria [ph], got off to a slow start. It’s growing nicely now. Madrid got off to a much better start and it’s growing nicely.”

 

People come to Costco for the value. Not for American Express card

“Our view has been we don’t think that many people left Costco, because they can’t use their American Express card. American Express is a great brand and it was a great relationship for many years. But at the end of the day, they are coming to Costco because of our quality in our value.”

 

Online retailers are only taking “a little piece” from Costco

“The internet is taking from everybody. Our view is it takes a little less from us. And interestingly, when you look at the categories within our slightly lower sales over the last couple of few months, the categories that have buffed that trend have been discretionary nonfood categories like apparel and housewares and electronics. So, now when we look at food and sundries, we absolutely do not believe its delivery services. We do absolutely believe its deflation more than anything. But again, everybody takes a little piece of something.”

 

Costco will not compete with online retailers on their turf

“We are recognizing – we recognized that we are not going to be the provider. We may be the provider to somebody that wants to deliver like an Instacart or Google Express, but we are not going to be dropping off small items and our prices at your doorstep. That being said, we are, we have and we continue to add things… I think you are going to see big differences literally in the next several weeks of the types of hot items that you see on there on the non-food side in the treasure hunt. On the – I think that’s probably the biggest thing you will see… Our success has been based on pricing value, quality and quantity at the lowest possible price… we look at our core business of getting you in the store still is paramount to what we want to do.”

 

Furthermore, Costco acknowledges it is not Amazon or Internet proof, and reinforces that it will stick to its value proposition to bring people in-store

“I read the reports that some of you have written about that we and maybe one or two other retailers out there that are unique are Amazon proof or Internet proof. We don’t buy that for a minute. We do believe that we do rely and we do expect we are going to be impacted loss. We also don’t believe we have to go crazy on the other side, but we want both. But our value proposition is best served for us when it’s in-store getting members to come in and buying when they can see everything there that we have.”

 

Main purpose of gas is to get customers into the store

“When prices went down, our view is as retail gas, overall, they would lower their prices but not as much as they could have. And we lowered it more than that and we are still able to benefit a little from it. So that was a positive. I think yes, it’s the value proposition more than anything that gets people in our parking lot.”

 

Costco’s competitive position on price is stronger than it’s ever been

“But at the end of the day, if anything, our view is – the mode has continued to get bigger, in other words, our competitive position, pricing wise, is stronger than it’s ever been. But we are not resting on that. We are constantly trying to figure out how to widen it. That’s what we do.”

 

Organic food category growth trend continues strong and resonates well with millennials

“We expect organic to be up 20% this year. Now, some of that will be some cannibalizing of some traditional, conventional, but no, it’s the perfect items for us, because it’s our member. It helps us with millennials on top of that. We get that. It creates a bigger competitive pricing mode, because we have as good, if not better quality at much better pricing. In terms of supply, I think the supply is starting to catch up with the demand out there and I think that some of the – you have heard me talk in the past about many of our global sourcing initiatives, I think that’s going to continue to help us and make it more competitively advantageous to us.”

 

Millennials shop more often but buy less. In the aggregate they buy a little more

“What we were surprised at is that they actually shopped a little more frequently while a little less each time, but the aggregate of those two, they bought more over that year a little more, I mean, in the low single-digits, but there was more. It didn’t have a bracket around it. And they renewed at a slightly higher rate.”

Costco (COST) Q4 2016 Earnings Call

Costco (COST) CFO Rich Galanti said certain departments in their business are experiencing deflation

“I had mentioned earlier we have recently seen a little pickup in the level of deflation overall. Some categories in the low to mid single-digits – in the low to mid single-digit range and several fresh food categories, notably meat and pork and things like that in the 5% to 10% range in some cases. Overall though, we are seeing net increasing deflation, but not in those levels and some non-food levels as well – non-foods as well.”

Despite a rough start, they believe they’ve successfully converted most members to the new Costco Visa credit card

“A few basic stats on the new card, approximately 11.4 million American Express co-branded cards, representing about just under 7.5 million accounts were transferred over to Citi during the conversion. Nearly 85% of those cards what we considered active, that is the card had been used for purchases over the previous 60 days. Currently, over 85% of the accounts transferred over have now been activated with Costco. And since June 20 and just the past many weeks, 1.1 million members have applied for the new card and over 730,000 new accounts have been activated or a little over 1 million additional Citi Visa cards in circulation. It’s still early. We launched only 14 weeks ago, but so far, we are beating our initial expectations in terms of conversion, usage and new sign-ups to the card.”

Their business model is about relentlessly trying to figure out ways to drive costs down so they can share the savings with customers

“simplest answer is that just like when we buy a physical product better lower we can buy whether it’s lower freight, greater purchasing power or greater production efficiencies or whatever we figure out with our supplier, we generally wanted 80% or 90% of that, the vast majority of it given back to the customer in terms of lower price because that’s what drives us and drives our business. And if we do it more next year, we will give 80% or 90% of that back. That will drive value to that member and loyalty to us and also more business to us.”

They believe Amazon is affecting their business yet are combating that by trying to get more people in their stores 

“The internet in general is going to take its percentage of different categories. It’s going to impact different categories and different retailers of such categories at different levels. I read the reports that some of you have written about that we and maybe one or two other retailers out there that are unique are Amazon proof or Internet proof. We don’t buy that for a minute. We do believe that we do rely and we do expect we are going to be impacted loss. We also don’t believe we have to go crazy on the other side, but we want both. But our value proposition is best served for us when it’s in-store getting members to come in and buying when they can see everything there that we have.”

 

Costco FY 3Q16 Earnings Call Notes

Richard Galanti

Customers are pretty healthy

“Okay. Well, in terms of the customer, so far so good. We don’t see any dramatic change. Many of you have asked questions or have had some concern about traffic coming down from this 4% plus number over seven years. We feel pretty good about where our numbers are. We don’t really see a lot of different changes.

Interestingly, when you look at nondiscretionary items like food and sundries versus discretionary items across the nonfoods categories, including big-ticket items like furniture, electronics and the like, we’ve actually had, relatively speaking, a little more strength in some of those nonfood categories. So that I think allays some of any concerns that some people have had.

But generally speaking, I’d have to say our customers are still pretty healthy and we are still getting good renewal rates notwithstanding a very small impact from some of the credit card transitions and so we feel pretty good at this point about that.”

Any weakness more deflation than dot com

“By the way, one of the other data points I’ve been asked several times in the last few weeks each time we’ve reported sales in the last couple of months is is it deflation, is it weakness, is it dotcom, whatever.

The fact of the matter is, if you like at during the 12-week quarter on a year-over-year basis, if we just take the average items per unit in the basket going through the front end, US only, so US only, it was up 1.4%. So we are getting people to buy more items, if you will.

The average basket value is up 0.4%. The simple implication there is you’ve got deflation presumably — deflationary pressures of about 1%. Now that’s a good educated guess. There could be other impacts of sizes, but typically we go into bigger sizes, not smaller sizes and bigger pack sizes.

So I think overall there’s probably still a little bit more deflation that we’ve seen over the last couple of quarters spread to other items in the nonfood category as well as we’ve seen.”

There’s no giant surprises either way in May

“Well, we really can’t talk to anything about May yet. There’s no giant surprises in either direction. But, at the end of the day — and again, the comfort level — I think I was — earlier in the call, I was responding to many calls that I received from both institutional investors and analysts out there about the concern.”

Costco (COST) Q2 2016 Earnings Call Notes

Costco (COST) CFO Richard Galanti said weaker international currencies continue to impact their earnings results 

“During the quarter the foreign currencies where we operate continue to weaken versus the U.S. dollar in all countries but primarily in Canada, Mexico and Korea, resulting in our foreign earnings in the second quarter when converted into U.S. dollars being lower by about $32 million or $0.07 a share and if exchange rates had been flat year-over-year.”

And lower gasoline prices hurt their overall revenue

“For the quarter, sales negatively impacted by gasoline price deflation to the tune of 80 basis points.”

They are seeing more deflation than inflation of across the goods they buy

“Final comment on deflation. Beyond gasoline price deflation that we’ve always pointed out each month, we have seen a little additional deflation across many merchandise categories such that sales have been impacted a bit by – a little bit more in the past couple of months.  in the U.S., we’re seeing deflation in the low-single digit range for foods, sundries and fresh foods, and now, again, a little bit more on the non-food side as well.”

Seeing strong membership renewal rates

“And in terms of membership, renewal rates remain strong; 91% in the U.S. and Canada and 88% rounded up in worldwide. Continuing increasing penetration in the Executive Member I think helps that. New membership sign ups in Q2 company-wide were up 4%.”

Costco (COST) CFO Richard Galanti said they are raising starting wages for the first time since 2007

“This year we’re also changing the starting level or entry level hourly wages. This is the first change to the entry level wages in nine years. Since 2007 our entry level wage in U.S. and Canada was $11.50 or $12 an hour. Effective this month in the U.S. and Canada, we’re increasing our starting wages from $11.50 and $12 to $13 and $13.50. So up a dollar and a half.”

Their E-Commerce business is growing at a substantial rate

“Next, Costco e-commerce, Costco online. We’re now in six countries, having recently opened in Korea and Taiwan. We’re also of course in the U.S., Canada, U.K. and Mexico. For Q2, sales and profits were up over last year. Our total sales were up 19% in the quarter, up 22% ex-FX and on a comp basis, up 18% reported and up 21% ex-FX. So continued good results in terms of growing our e-commerce efforts.”

Costco (COST) CFO Richard Galanti said they look at their stock price to time their stock buyback program

“During the first five weeks of the past quarter, very little stock was repurchased. In fact, of the total $80 million, $3 million of the $80 million was purchased in the first five weeks, and the remainder, the vast majority was in the last seven weeks. And that’s purely a function of how we do it. We look at kind of a matrix pricing. As it goes up a little, we buy a little less, when it comes down a little, we buy a little more. As long as we feel comfortable about our runway, I think we’ll continue do that.”

Continuing to change product mix to increase frequency of customer visits

“The fact that we keep adding some gas stations is driving frequency. I remember years ago, I’ve heard for 30 years, now that this thing is maxing out, fresh foods or gas stations, whatever it is, we keep figuring out new things. And I feel good about some of the things we’re doing in a lot of the non-foods categories. Fresh foods never ceases to amaze me, and we’ll keep going.”

They say E-Commerce doesn’t affect their business as much as it would other retailers

“I’m sure there’s somebody that made one less trip to Costco because they bought something online or somewhere else. But I think we’re still doing a pretty good job of getting them in the door particularly with fresh foods, with gas for the Executive Member with a quality co-brand offer in terms of rewards. So all those things help.  And some of those pieces, we’re not going take. We’re not going take the single unit items, some small-value food and sundry things that are going to be delivered to your door by 7 in the morning if you ordered six hours earlier. That’s not us. We can’t do that at 10% and 11% margins. We’re taking little pieces of other things.”

Costco (COST) CFO Richard Galanti highlighted which items are seeing price decreases

“So again, that would indicate to me again we’re seeing a little bit more deflation. I can give you crazy numbers on given items. On a year-over-year basis, when you look down, just candy. M&Ms down 10% year-over-year. American single slices of cheese down 15%. Bacon down 20%”

Organic food is now a large and still growing category

“Yeah, we’re about $4 billion, which was I think in the last two years, it was up 30%-ish. And we’re on task, I think our goal this year to have a double-digit number that has a two in front of it, and we feel good about it. We are I think doing as good a job as anybody in terms of sourcing. And part of the challenge is availability. And the industry is growing, needless to say. There are more farmers and more poultry producers and more beef producers that are committing more to this. And we’re certainly out there literally in the fields here and abroad getting these growers and processors to do more. So, I think it still has some good opportunities there.”

Costco FY 1Q16 Earnings Call Notes

Costco Wholesale (COST) Q1 2016 Results – Earnings Call Transcript

Mr. Richard Galanti, CFO

Late November was quite a bit stronger than early November

“it’s October when we said one month does not make a trend. And then the first couple of weeks of November weren’t terribly exciting and then it got more exciting. And middle of November and late November, it was quite a bit stronger than the first part of November.'”

Electronics has turned, fresh foods has been great

“I think if you’d ask me what surprised me in the last month versus the last couple of months, electronic has finally turned and that’s I think a function of people coming in, pricing keeps coming down. I think our fresh foods has been great.”

Consumer spending is back to the old cadence, but…

“Yes, but that doesn’t mean anything for tomorrow.”

Lower prices are helping with TVs as is 4k

“I think the technology, the 4K is helping, but the prices are coming down as well. I was there across the street yesterday and you’ve got smaller flat screens with great quality less than $200. You got bigger TVs less than $1,000. You got as well the giant HD 4K whatever under $3,000 and under $2,000, depending on the size and some of the new technology. So I think all those things are helping us a little bit on that category.”

We’re in our competitors’ stores each week and we assume they’re in ours

“we are our own toughest competitor and I mean that, in our industry, notably Sams and to little extent BJs, but certainly many locations where we compete head to head. We’re in their locations literally every week and I would assume they are in our locations every week. And we feel good about the competitive posture there.”

Costco 4Q15 Earnings Call Notes

Comp sales -1%,, but +6 excluding gas price deflation and FX

“fourth quarter fiscal 2015 operating results, net sales for the fourth quarter came in at $35 billion, up 1% overall a year ago. Comp sales were down 1% on a reported basis, but were up 6% including the negative gas and FX impacts. Gas prices for the quarter were down 21% year-over-year, negatively impacting U.S. comp figures by little more than 3 percentage points, so a plus 6 U.S. comp, excluding gas price deflation.”

Growing ecommerce methodically

“we’re doing it methodically. We’re not going to go crazy out there. I think our mobile apps have improved and will continue to improve. And we like the value proposition we have. We’re recognizing that we can’t be everything to everybody, that’s not what we do for a living, and but we have great value. We also like the fact that some of these other services are buying from us. Some of our top customers are some of those guys. So if we can’t deliver that single unit of milk or cereal to your doorstep, someone that is may want to buy from us.”

We’re not going to have the most items online, we’re not going to be the fastest to deliver, but we will compete on price. Our margins online are slightly lower.

“In terms of e-commerce, first we definitely chose – for us, we have a lot more items. We have 8,000 or 10,000 or so instead of 3,700 in store. That’s a nit compared to everybody else out there that has hundreds of thousands, if not millions of items. I think what separates us is we’ve got certainly we and others will have great quality merchandise. We’ve got the best pricing overall. We work on margins that are at/or slightly below our reported total company margins but up there high singles, very low double digits. We will compare that to anybody out there. Again, we recognize we’re not going to be selling single items to govern within an hour or four hours or overnight necessarily.”

There is room for all of us online. We still want people to come into our warehouses though

“There is room for all of us. We’ve got to keep, it’s a big play out there in terms of market share and we think that we’ll be able to take our share of that. Some little departments you lose a little, others you make a little, certainly we want people to still come into our warehouses.”

Give pricing back to the customer

“Overall, we try to improve margins a little by lowering prices and I mean that sincerely and we’re going to give most of that back to the customer to our member. As you know, we are pretty stubborn and intent on maintaining in a rising commodity standpoint prices on certain fresh food so we’ve seen some impact there to the negative.”

Trying to be more open minded in marketing

“Well, first and foremost we’ve learned from doing virtually nothing to be a little more open minded about it I think there’s a lot of low hanging fruit that we haven’t done certainly there’s more efforts in these areas in our membership marketing team on dotcom a little bit.”

Make more per gallon on gas at lower prices

“when prices are low, we make more than we used on average per gallon or per gas station, and that’s good.”