COST | Delivers Solid 4Q – More to Come

Costco (Best Idea long) delivered an exceptional 4Q – and based on the muted after-hours reaction, the market couldn’t care less. It’s almost written in the cosmos that this stock goes down on great numbers. The company put up a monstrous 14.1% comp (ex gas and FX), with 13.6% growth in the US, and 18.8% Internationally. Traffic was down 1.2%, as expected, as consumers consolidate shopping trips and COST limits the number of guests in each store at any given time. But that was more than made up by 12.7% increase in basket size. The biggest driver was e-commerce, which we think will be an increasingly important of the COST story – and was up 91% in the quarter (only ~8% of sales, or 10% including Instacart). If we include 3^rd party transactions e-comm grew 120%. Health, beauty, home and electronics were particularly strong, and online groceries were up ‘several hundred percent’. Despite food inflation, we saw an 18bp increase in Gross Margin, and the company levered SG&A by 47bps. Gas deflation remains a headwind for COST, both in cost per gallon and gallons consumed – though gallons consumed are down only 10%, which is more bullish than national trends in miles-driven. There were a multitude of non-recurring items, which COST embeds in the numbers instead of stripping them out as ‘special charges’ (as lesser quality companies usually do). The quarter had $281mm ($0.47 per share) in premium wage and sanitation costs related to Covid – which is higher than the company guided last quarter. There was also $0.06 per share in costs related to the prepayment of $1.5bn in debt during the quarter. Lastly, there was a $0.15 per share benefit from the reversal of an accrual from last year. While COST is leveraging $14mm in higher weekly wage costs, management noted that these should be considered temporary. We’ll take the other side of that argument. Higher wages can’t simply be taken away from employees without adverse impact. We’re modeling that the higher costs are here to stay. All in, we saw the 14% comp flow through to 32% EBIT growth – despite the higher costs in the quarter. While the market is clearly beginning to discount that this covid winner will give back its growth in year 2 of the pandemic, we’re of the view that there is a permanent shift in consumer shopping patterns that will accrue to COST. While 27% EPS growth (like we saw in 4Q) isn’t the norm for this company, we think that 10-12% will be, and yet the consensus is looking for just 2-3% EPS growth next year. The punchline is that there’s more earnings upside to come over the next year. We don’t want to be too greedy in overstaying our welcome on this name as it’s trading at 20x EBITDA and 36x earnings. But so long as we see upside to the model, the name remains a Best Idea long.