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Why Costco’s Fiscal Q4 2018 Margins Could Remain Weak

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Sep. 27 2018, Updated 6:31 a.m. ET

Margin headwinds

Costco’s (COST) profit margins could remain weak during the fiscal fourth quarter. The company’s investment in price to widen the value gap with its peers and its higher supply chain costs are expected to impact its margins. However, improved comps, higher membership fee income, and the credit card transition could cushion its margins.

Among Costco’s peers, Walmart (WMT) and Target (TGT) have also disappointed investors with their margin performance. Their margins were impacted by value offerings, expanded fulfillment options, investments in growth measures, and higher transportation costs.

However, investments in growth measures have enabled Costco, Walmart, and Target to defend their market share, drive traffic, and stabilize sales despite strong competition from deep discounters and e-commerce giant Amazon (AMZN).

Costco is focusing on reducing its SG&A (selling, general, and administrative) expense rate. However, lower gross margins could offset the benefits of these lower costs.

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Revisiting the previous quarter

During the fiscal third quarter, Costco’s (COST) gross margin rate contracted 46 basis points, reflecting increased freight costs, investments in price, and low margins from higher gasoline sales. Excluding the changes in gasoline prices, Costco’s gross margin fell 28 basis points. Although the company reduced its SG&A expenses, its operating margins declined slightly due to weak gross margins.

In comparison, Target’s gross margin fell ten basis points during the last reported quarter, reflecting higher digital fulfillment costs. Walmart’s gross margin rate also remained weak, reflecting price investments and higher transportation costs.

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