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Why Costco’s Fiscal 4Q17 Margins Disappointed Investors

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Increased investments dented margins

Investors expected Costco Wholesale (COST) to post improved margins, especially given its strong sales and increased savings from co-branded credit card offerings. However, the company’s increased price investments to drive shoppers to its stores and fend off growing competition in the grocery space adversely impacted its margins in fiscal 4Q17.

In comparison, Walmart (WMT), Target (TGT), and Kroger (KR) also witnessed margin pressures due to their continued investments in e-commerce platforms and prices to bring in value-driven buyers to their stores.

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Margin performance

Mass merchandisers and grocery retailers are investing in growth initiatives, including strengthening of their digital arms and lowering prices to compete against Amazon (AMZN) and deep discounters such as Aldi. This, in turn, is taking a toll on their margins.

As for Costco, its growth initiatives were expected to be funded by the increase in membership fee income and higher cost savings. However, its gross margin fell 15 basis points to 13.3% in 4Q17 as benefits of the measures mentioned above were more than offset by higher price investments.

During the reported quarter, improved margins in food and sundries and softlines were offset by lower margins in the fresh and hardlines category. Gross margin remained low at its ancillary and other businesses as higher margins from gasoline, business centers, and hearing aids were offset by declines in pharmacy and e-commerce, reflecting higher price investments. The company’s operating margin improved slightly to 3.4%, reflecting a fall in SG&A (selling, general, and administrative) costs.

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