3 Takeaways From Costco's Earnings Report

By Markets Fool.com

Costco's (NASDAQ: COST) stock rose last week after the warehouse retailer posted its quarterly earnings results. The company overcame deflation in the grocery industry and a major disruption in its membership base to show steady sales and profit growth. On the other hand, it revealed a slowdown in customer traffic gains.

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With that big picture in mind, here are a few key takeaways for investors from last week's report.

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Slowing sales growth

Revenue growth was steady for the quarter but slowed down overall. Costco reported flat comparable-store sales that, after adjusting for swings in the price of gasoline, were up 3% -- or on par with the prior quarter's result.

There's no question that the longer-term trend is showing a downtick in the retailer's growth pace, though. Comps were 4% for the full year, compared to 7% in fiscal 2015 and 6% in each of the previous four years.

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Comp sales excluding currency changes and gasoline price swings. Data source: Costco financial filings.

The good news for investors is that the warehouse giant continues to lead the industry in growth. Wal-Mart (NYSE: WMT) is expanding at a below-2% pace and Kroger (NYSE: KR) recently had to lower its 2016 outlook as its comps slumped. Yet Costco's awesome customer traffic growth streak (seven straight years of 4% or higher gains) has ended. Executives said traffic ticked up by 2.5% this quarter, compared to 3% in the prior quarter.

Positive membership trends

Membership fees, Costco's real engine of profits, rose by a healthy 6%. That gain helped net income tick higher by 2% to $779 million, translating to $1.77 per share of earnings. Consensus estimates, meanwhile, were targeting just $1.73 per share. It was the first time in three straight quarters that Costco beat, rather than missed, earnings expectations.

In a conference call with investors, Costco's management said the fee results were boosted by membership growth as the retailer opened up 10 new warehouses. Executives also succeeded at pushing the executive membership tier that provides bigger shopping benefits in exchange for a higher yearly charge. That segment now accounts for roughly one-third of the membership base -- up from 25% a decade ago -- and Costco aims to push that figure up to as high as 50% over time.

The company's aggressive store expansion pace should keep membership numbers climbing higher. Costco opened 29 new warehouses last year, and plans to do the same this year, compared to 23 store launches in fiscal 2015.

Fees and renewals

Investors should keep a close eye on subscriber renewal rates over the next few quarters. After remaining at a record high last year, they ticked lower recently. The latest decline was to 90.3% in the U.S. from 90.4% in last year's Q4:

Renewal rates in the U.S. Data source: Costco financial filings.

Chief Financial Officer Richard Galanti told analysts that the decrease was likely a temporary issue connected to the switch-over in co-branded credit card (toAmerican ExpressfromVisa). Costco pulled a similar change in the Canadian market and renewal rates dipped there before rebounding roughly 18 months after the switch opened up credit card applications again. If that pattern holds in the U.S., renewal rates might look weak for another few quarters.

The second big wild card is membership fees. Now that Costco has put its tricky credit card change behind it, executives might finally be ready to pull the trigger on raising the annual cost of membership. After all, it's been nearly six years since the last increase and the retailer has raised prices about every five to six years. The next hike should give a solid boost the company's bottom line, but it won't happen until management is feeling confident about the strength of its membership metrics.

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Demitrios Kalogeropoulos owns shares of Costco Wholesale. The Motley Fool owns shares of and recommends Costco Wholesale and Visa. The Motley Fool recommends American Express. 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.