Costco Wholesale Corporation Earnings: Another Miss

By Markets Fool.com

For most of the past three decades, Costco Wholesale has been one of the most consistent growth stories in the retail industry. However, on Wednesday night, it reported a second straight quarterly earnings decline along with a slowdown in comp sales growth. This could test some investors' patience.

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Costco earnings by the numbers
Costco posted slow revenue growth again in its second fiscal quarter, as the strong dollar and (to a lesser extent) falling fuel prices offset its underlying comp sales growth. Here are some of the company's key performance metrics from last quarter.

Metric

Q2 Result

YOY Change

Revenue

$28.2 billion

Up 2.6%

Comp Sales Growth (Reported)

N/A

Up 1%

Comp Sales (Ex-Fuel/FX)

N/A

Up 5%

Operating Margin

3.04%

Down 15 basis points

Adjusted EPS

$1.24

Down ~1%

Data source: Costco Q2 2016 earnings report.

Revenue reached $28.2 billion, up 2.6% year over year. Comp sales rose 1% year over year, but would have increased 5% but for the negative impact of lower gas prices and the strong dollar. Currency fluctuations had a particularly big impact in Canada, where comp sales rose 10% in local currency but declined 7% in U.S. dollar terms.

New warehouse openings also contributed to Costco's revenue growth. The company ended last quarter with 698 warehouses, up from 671 a year earlier.

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Costco's revenue growth was offset by a decline in its operating margin. Gross margin increased by 17 basis points year over year, but operating expenses rose at an even faster rate. As a result, it posted adjusted earnings per share of $1.24, down from $1.25 in Q2 of fiscal 2015. On average, analysts had expected EPS to rise modestly to $1.28.

Sales growth is slowing
Even excluding the impact of fuel price and foreign exchange volatility, Costco's comp sales trend has been slowing recently. The 5% increase recorded in Q2 was worse than the 7% gain Costco achieved for the full 2015 fiscal year.

Costco's comp sales growth is slowing.

Furthermore, Costco's adjusted comp sales growth dipped to 4% in December and then to 1% in January. On Wednesday, the company reported adjusted comp sales growth of 4% for February, which remains well below its long-term trend.

To be fair, Costco is facing extremely tough comparisons right now. Adjusted comp sales rose 8% in Q2 2015 and for the month of Feb. 2015. In that context, 4%-5% growth seems pretty good. Nevertheless, investors have high expectations for Costco's performance, which is reflected in the stock's high earnings multiple.

Will Costco bounce back?
On the earnings front, Costco has been facing a number of unusual headwinds recently. The two most notable ones are the effect of the strong dollar on revenue and earnings in international markets and the impact of Costco's credit card transition in the U.S.

These are both short-term issues, though. It's hard to know when other currencies will stabilize against the dollar, but it will happen sooner or later. Meanwhile, the credit card shift will become a big tailwind starting this summer, as Costco begins to reap the benefit of even lower card acceptance fees. This should spark a return to earnings growth by Q4 at the latest.

However, in the long run, Costco will need to generate faster comp sales growth to justify its premium valuation. There's no easy fix for this. Thus, investors should pay close attention to Costco CFO Richard Galanti's commentary on sales trends during the upcoming earnings call.

The article Costco Wholesale Corporation Earnings: Another Miss originally appeared on Fool.com.

Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale. 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.