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The Secret to Costco's Future Success

Dan Caplinger, The Motley Fool

There's no doubt that the e-commerce revolution has had a marked impact on the retail industry. Shoppers simply don't visit retail locations like they used to, and many big-box stores have seen dramatic declines in traffic and revenue as a result. Yet all along, warehouse pioneer Costco Wholesale (NASDAQ: COST) has found ways to overcome challenges and grow its business, sticking to its original business model while seeking ways to innovate and keep up with the pace of technological advances in the e-commerce world.

Costco will announce its fiscal third-quarter earnings on Thursday, May 31, and investors have high hopes that the company will be able to sustain its winning ways. The stock currently trades at all-time highs near $200 per share, and with tailwinds coming from an improving industry environment, lower tax rates, and a solid economy, Costco shareholders want to make sure that the warehouse retailer can rely on the secret of its future success: its relationships with its loyal customers.

Key stats on Costco

Metric 

Value

Expected EPS Growth

20%

Expected Revenue Growth

9.4%

Forward Earnings Multiple

26

Expected 5-Year Annualized Growth Rate

11.7%

Data source: Yahoo! Finance.

What's ahead for Costco?

Investors are excited about Costco's earnings prospects, having made significant increases to their profit expectations in the past three months. They've raised their projections for fiscal 2018 by roughly 5% over that time period, and they've made smaller but still meaningful adjustments higher to earnings for fiscal 2019 as well. The stock has followed suit, moving upward by 8% since late February.

Costco's fiscal second-quarter results didn't entirely satisfy investors, although some one-time impacts might have made it difficult for those following the stock to focus entirely on the fundamentals of the warehouse retailer's business. Comparable sales were higher by 8.4%, although roughly 3 percentage points of those gains came from the impact of higher gasoline prices and the weaker U.S. dollar. The loyalty of Costco's customer base showed up in the growth rates for the company's membership fee revenue, which was higher by about 12.5%. Slow but steady expansion efforts continued with the opening of a few new store locations during the quarter, and Costco also likely benefited from the decision from rival Sam's Club to close a substantial number of its own warehouse locations.

Costco Wholesale logo in red and blue letters.

Image source: Costco.

Monthly sales results from March and April suggest that growth trends will continue. In March, total comps were higher by 8.6%, with adjusted figures taking out the impact of gasoline and foreign currency pointing to a 5.8% rise. Growth accelerated in April, with an overall 10.9% rise in comparable sales working out to 7.3% after adjusting for currency and gas-price effects. The Easter shift was an important component in comparing the two periods year over year, taking away from March's growth but helping out April by giving it an additional shopping day.

Investors have to be pleased about the confidence that Costco has in its own business prospects. In late April, the retailer made a big 14% boost to its quarterly dividend, going from $0.50 to $0.57 per share every three months. Skeptics will note that a $2.28 annual dividend still works out to less than a 1.2% dividend yield at current prices, which is well below the market average. Far more important for investors have been Costco's special dividends, which included a $7-per-share payout last year and a $5 dividend at the beginning of 2015.

Yet the real key to Costco's winning ways has been the willingness of shoppers to remain members and come to Costco's stores. Despite CFO Richard Galanti's concerns about shifting consumer trends that involved shoppers "never wanting to leave their house and only typing stuff to order and get it at the front door," Costco has made smart initiatives to stay competitive, including delivery of perishable items through a collaboration with Instacart. With e-commerce comparable sales having climbed 33% in March and 43% in April, it looks like those moves are paying off and will continue to do so.

When Costco reports earnings, investors should pay special attention to membership fee revenue and watch for news of further collaborative efforts on the e-commerce and delivery services fronts. With so much at stake in order to woo a new generation of shoppers to become members, Costco needs to be smart about expanding its services while remaining true to the strengths of its core business model.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.