What drives margins?
Costco Wholesale’s (COST) margins are expected to benefit from increased fuel earnings and improved store traffic. However, the strong US (SPY) dollar and higher promotional activities are likely to remain a drag.
By comparison, rivals Wal-Mart Stores (WMT) and Target (TGT) are expected to post sluggish margins in its current fiscal year on account of increased price investments, in an effort to remain competitive and deflation in the food category. Both of these companies are making increased investments to strengthen their digital arms in the wake of increased competition from Amazon.com (AMZN), which is projected to hurt Costco’s margins.
Why Costco’s margins declined last quarter
Despite reporting an improvement in sales, Costco’s gross and operating margins decreased as lower gasoline earnings due to the inflation in fuel prices and increased sales penetration took a toll on margins. Increased promotional activities and deflationary margin pressure have also dragged margins down.
Costco’s gross margin (as a percentage of net sales) contracted 24 basis points in fiscal 2Q17 to 11.0%, while its operating margin fell 21 basis points to 2.9%, reflecting lower gross margin and increased pre-opening expenses related to four new locations and its entry into France and Iceland. These costs were offset in part by lower SG&A (selling, general, and administrative) expenses as a percentage of sales.
Analysts project that the company will post healthy margins as challenges from lower fuel earnings are likely to abate. Costco is also expected to benefit from its Citi Visa co-branded credit card facility, which means lower fees for the company. Meanwhile, the company’s planned increase in its membership fee is likely to boost its margins in coming quarters.