Costco: How was the excellent performance built?

The following is the summary of the conference call for the Q1 2025 financial report of $Costco Wholesale(COST.US) For the financial report interpretation, please refer to Costco: This is what it means to be a "Retail King" across cycles

1. Core Information Review of the Financial Report:

2. Detailed Content of the Financial Report Conference Call

2.1. Key Information Presented by Executives:

Business Growth Highlights

- In Q1 of FY 2025, 7 new warehouses opened, including 1 relocation, resulting in a net increase of 6, with 4 located outside the United States.

- The 897th warehouse was opened in California the day before Thanksgiving, achieving sales of $2.9 million on opening day, setting a new record for sales on the opening day of a warehouse in the United States.

- It is expected that 29 warehouses will be opened in FY 2025, including 3 relocations, resulting in a net increase of 26, with 10 located outside the United States.

Core Product Sales

- Fresh Food Department: Comparable sales grew in the high single digits in Q1, leading core product sales.

- Meat Department: Double-digit growth, with consumers purchasing both high-priced quality cuts and low-priced per pound options.

- Non-Food Department: High single-digit growth, despite calendar changes. Categories such as gold jewelry, gift cards, home goods, sports goods, health and beauty products, luggage, kiosks, and hardware all saw double-digit growth, with several high-quality brands added this quarter, such as Peloton, Wrangler, Springfree Trampolines, and Ruggable.

- Food and Daily Necessities Department: Mid-single-digit comparable growth, with refrigerated and frozen food departments leading. New international food items showed strong momentum, such as pork soup dumplings from Si Nian, Sonama Mori rice, and hot pot beef slices. Kirkland Signature grew faster than the overall business, with some products seeing price reductions this quarter, such as Kirkland Signature Organic Peanut Butter, Chicken Stock, and Sauvignon Blanc, while new products like Kirkland Signature Oxy Powder and Food Storage Bags were also launched Auxiliary Business

- Pharmacy: The strongest sales growth, focusing on maintaining low prices and leveraging technology for member convenience, such as introducing new prescription inventory management software and delivering prescriptions through Instacart.

- Food Court and Optical Departments: Performed well this quarter.

- Gas Sales: Sales were down in the low double digits due to a decrease in average price per gallon.

- Costco Travel: Offers unique member value, with services well-received by members, including vacation packages, car rentals, cruises, hotels, and flights, with members spending about twice as much on this service compared to non-users. Introduced some interesting data about travel business, such as the number of car rentals last year could fill the Costco parking lot in the U.S. 8.5 times, along with some information related to cruise bookings.

Digital and E-commerce Business

- Continued to advance the technology roadmap, with features like viewing warehouse inventory through the Costco app being well-received. The U.S. app had 2.9 million downloads this quarter, with a total of approximately 42 million downloads.

- E-commerce traffic, conversion rates, and average order value all grew year-over-year, driving comparable sales growth. Categories such as hardware, sporting goods, gift cards, and home goods saw double-digit year-over-year growth in e-commerce sales.

- Costco Logistics performed excellently this quarter, with Costco Next setting sales records during Thanksgiving, Black Friday, and Cyber Monday.

Retail Media Business

- This quarter completed the first targeted media campaign with one of the largest CPG partners through third-party media channels, achieving an advertising spend return of 2 - 3 times, with the retail media team collaborating with over 25 vendors for the next wave of off-site activities.

Net Profit

- Q1 2025 net profit was $1.798 billion, diluted earnings per share $4.04, compared to $1.589 billion in the same period last year, with diluted earnings per share of $3.58.

- This year includes a $100 million tax benefit related to stock compensation (diluted per share $0.22), while last year included a $44 million tax benefit (diluted per share $0.10).

- Excluding discrete tax items, net profit and diluted earnings per share grew 9.9% and 9.8%, respectively.

2.2 Q&A Analyst Q&A

Q: Diagnosing consumer health, how to clear seasonal inventory (such as clothing, high-priced items)? Talk about market share in some non-essential categories?

A: Consumers focus on the novelty, quality, and value of goods. Non-food categories performed strongly, with categories like gold jewelry and gift cards seeing double-digit growth this quarter. In food and grocery, there has been a shift from dining out to home food, with strong sales in meat and produce, as consumers show a tendency to purchase high-quality meat and low-priced poultry, beef, and pork Data shows that market share is growing in most categories mentioned.

Seasonal sales are strong, furniture, appliances, sporting goods, and hardware are driving e-commerce sales.

Q: What are your views on future key drivers such as foot traffic, average transaction value, and changes in product mix? What about the incremental situation of emphasized retail media?

A: Satisfied with foot traffic and shopping frequency, after adjusting for foreign exchange and gasoline impacts at the end of last quarter, average transaction value has turned positive, with slight growth of over 2% in the U.S. and 2% globally this quarter. This is attributed to merchants offering quality products and good execution by operational staff. Retail media is an incremental opportunity, and the interest seen so far mainly comes from marketing agencies, which is an opportunity to tap into new marketing funds.

Q: What are the drivers of core profit margin performance this quarter? Thoughts on reinvesting in expected price declines in the supply chain, and what does the hardware category include?

A: In terms of core profit margin, food is basically flat, non-food has slightly declined, and fresh produce has slightly increased, with an overall increase of 3 basis points.

The hardware category includes household items such as storage, plumbing, lighting, power tools, and batteries. The company will continue to focus on pricing, possibly maintaining certain prices while asking members and suppliers to jointly lower prices.

Q: What are the differences in renewal rates between online and offline registered members, and the differences in online behavior? What is the contribution of the third-party market Costco Next to retail media growth, and will it affect member loyalty?

A: Satisfied with the basic metrics for members, more new members in recent years have come from digital channels, the renewal rate for new members recruited through digital channels is slightly lower than the historical baseline. Member renewal rates are reported with an 18-month lag, and the subsequent increase in digital members will affect overall renewal rates.

Costco Next is a member-exclusive marketplace, curated by buyers, which will enhance relationships with members and meet shopping needs. Whether more third-party suppliers will use retail media services and the impact on numbers is still in the early stages and remains to be determined.

Q: What are your views on stock splits? What are your views on tariffs and their impact on inflation?

A: Costco has conducted stock splits in the past, there are currently no plans for a stock split, but it will continue to evaluate. Now retail investors and employees can purchase fractional shares, the economic benefits are not very clear, but stock splits have certain benefits for them. Regarding tariffs, there is a lot of uncertainty about timing and scope, making it difficult to predict the impact. Tariffs will increase costs, and when facing tariffs in the past, the company has procured inventory in advance, sought alternative sourcing locations, and worked with suppliers to reduce costs, while also considering product changes. About 1/4 of the company's business is non-food, with a small portion being imports, accounting for a minor share of overall business.

Q: What is the outlook for capital expenditures (CapEx), are there any significant changes, and are there different situations regarding projects or priorities?

A: No significant changes, the gradual increase in capital expenditures reflects the ongoing growth of the business, including opening new warehouses and cost inflation, while also investing more in technology. The company's philosophy is to focus on warehouses, invest in maintaining warehouse quality, invest in new warehouses, update the supply chain and warehouses, and also make technological investments Q: How does price investment (focusing on lowering commodity prices) compare in priority to other investments (such as product quality, IT labor, etc.)? What is the status of the international club project pipeline, especially regarding the number of controlled locations?

A: The reinvestment of membership fees is considered from a holistic perspective, including lowering prices, mitigating inflation impacts, improving member experience (such as employee wages), and ensuring more value for members through innovations like Kirkland Signature products. In the coming years, we expect to open 30 warehouses annually, most of which will be outside the United States, with opportunities in Canada and Mexico, as well as growth potential in Europe and Asia.

Q: Core profit margin (excluding gasoline) increased by 17 basis points; please elaborate on the driving factors, especially regarding the mix and co-brand credit card programs?

A: Overall, we are satisfied with the gross margin, which increased by 7 basis points after excluding gasoline impacts, with the core rising by 3 basis points. The main adverse factor was gasoline, affected by events in the Middle East, while e-commerce, business mix, and co-brand credit card programs provided benefits that offset the negative impact of gasoline.

Q: What is the growth runway in the U.S. market, considering industry competition, and what gives confidence in maintaining growth momentum in the U.S.?

A: The success seen after the opening of the Pleasanton warehouse alleviated pressure on high-traffic warehouses, with existing members visiting more frequently, new warehouses generating incremental business, and good performance in other locations like Scarborough. There is still room for growth in the coming years, with a focus on improving member experience.

Q: E-commerce grew by 13%; what is the updated penetration rate, and how does it look when including Instacart and Uber Eats? How is the penetration rate of private label products considering the newly launched products?

A: We are satisfied with the growth of digital business; November sales were affected by the calendar timing, but we are pleased with the adjusted trends, with increases in app downloads, traffic, and average orders. E-commerce accounts for 7% - 8% of total sales, and when including other businesses and excluding gasoline impacts, the penetration rate exceeds 10%.

The penetration rate of U.S. private label products is about 33%, primarily in food and daily necessities, growing faster than other businesses.

Q: What are the driving factors behind the company's traffic growth, and how will this growth be maintained?

A: It is the result of multiple factors working together, including the efforts of the procurement team and operations staff to meet members' demands for different price proteins, with contributions from various business segments such as pharmacies, food courts, and fresh produce areas.

Q: Have you seen competitive impacts (such as membership fee adjustments, Scan & Go technology, etc.)?

A: We are our biggest competitor; opening new warehouses will create some internal competition, but we also see incremental growth. The retail pharmacy business is growing, and the team is providing value to members and improving the experience.

Focusing on members, self-checkout is a good option, and we will continue to pay attention to technology to enhance the front-end experience; currently, Scan & Go is not a priority Q: Has the sales category been expanded, and has there been a change in profit levels for categories with low sales profits?

A: The company has been looking for new areas to meet member needs, such as caskets, gasoline, etc. Precious metals and gift cards are also results of the procurement team, and we will continue to seek new areas.

In addition to the efforts of the procurement team, these categories have other positive impacts on the business, such as driving traffic, promoting cross-selling, and increasing the visibility of digital business, without requiring other categories to increase profits to offset.

Q: Can you gain more wallet share from high-income consumers? Explain why the 2% rebate is beneficial for 5 basis points?

A: We believe we have the ability to gain more wallet share from high-income consumers and will continue to seek brands that offer quality products, such as Kirkland Signature.

The 2% rebate accumulates over the year, with adjustments in the first quarter. The adjustments this quarter offset the increases from the second half of last year, showing overall gradual growth but with offsets between quarters.

Q: Talk about the cooperation with Instacart and Uber, including lessons learned, growth rate, and contribution to sales, as well as members' awareness of the services?

A: We have a strong partnership with both, which has changed members' shopping habits and increased shopping frequency. It is an effective way to deliver small non-food items, improving the speed and convenience of e-commerce delivery.

Cooperation has grown strongly, at least in line with the overall growth rate of digital business, and even slightly higher.

Q: Discuss the labor relations with Teamsters and the current negotiation situation?

A: We will take care of employees as we have in the past, with a 40-year record of fair dealings with the Teamsters union, focusing on reaching agreements fairly and promptly.

Q: Discuss the performance of international business, with a compound growth rate decline compared to the fourth quarter; what changes are there by region?

A: There is nothing particularly noteworthy; the international market sometimes has slight differences due to varying holiday timings. Overall, we are satisfied with the momentum of international business development, with market share continuing to grow.

Q: Evaluate the online business from the perspective of appearance, feel, and functionality; how does it compare to competitors? Is the growth of online membership driven by the company or a result of the attractiveness of online business?

A: Over the past 10 years, the growth rate of our business has been faster than the overall growth of U.S. e-commerce. We are satisfied with the momentum and growth, but there is still room for improvement in areas such as search functionality and mobile app inventory. The goal is to continuously enhance the member experience.

We are currently doing foundational work, such as speed and stability, and there will be more improvements in the next 12 months. In terms of e-commerce membership registration, the execution of online registered members is relatively low, as they are less aware of its benefits. The company will subsequently demonstrate these benefits to them.

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