Supply Chain, Inflation No Match for Costco

Costco Wholesale continues to achieve impressive operating results despite supply chain and inflation pressures that won't be subsiding anytime soon.

In an earnings call with analysts, CFO Richard Galanti said the challenges include port delays, container challenges, COVID disruptions, shortages of various components, raw materials, ingredients, packaging supplies, labor cost pressures and truck driver challenges. And inflation is creeping up ever higher.

"Talking with our merchants, we estimate that overall year-over-year price inflation will be in the 4.5% to 5% range. That's a little bit higher of an estimated inflation rate that I discussed a quarter ago," he said.

Galanti said supply chain challenges are impacting every department.

"Overall, we feel we've dealt pretty well with the supply chain challenges in terms of delayed container arrivals on the Pacific Coast. About 79% of our import containers are late by an average of 51 days. Virtually all departments are impacted."

Galanti said computer chip shortages are still impacting many items, and toy in-stocks may be affected during the holiday period.

"In some instances, delayed inventory simply extends the season, an example might be lawn and garden and patio. As soon as the product arrives, it sells pretty quickly. But it may extend into beyond the normal seasonal time, toys and seasonal in fact, same thing, some inventory, in fact, won't make it before Christmas, but we've mitigated that as best as possible, and feel pretty good about it," he said.

As for the much-hyped cream cheese shortage, Galanti said Costco is in good shape when it comes to cream cheese.

"I had a bit of a chuckle at a call just yesterday from a reporter asking about how are we doing on cream cheese. And so I checked and there is a cream cheese shortage out there and the bagel shops are being challenged. We actually got it as the buyer said, it took a little extra work, but we've got all the cream cheese we need. So I think we've done a good job in merchandising."

For the first quarter ended Nov. 21, net income at Costco came in at $1.324 billion or $2.98 per diluted share compared to $1.166 billion or $2.52 per diluted share last year. Net sales for the quarter increased 16.7% to $49.42 billion, up from $42.35 billion a year earlier in the first quarter. Same-store sales for the first quarter were 9.9% excluding gas inflation and the impacts of currency fluctuations.

In terms of sales metrics, traffic or shopping frequency increased 5.9% in the U.S. during the quarter. Costco's average transaction or ticket was up 3.5% in the U.S. excluding the positive impact from gas inflation and currency fluctuations.

Membership fee income was $946 million, up $85 million or 9.9% from last year's $861 million figure. In terms of renewal rates, Costco's U.S. rate came in at 91.6%, up three tenths of a percent. Costco ended Q1 with 113.1 million total cardholders, an increase from 111.6 million total cardholders last quarter. Paid executive members ended the quarter at 26.5 million, up 836,000 from last quarter.

"The renewal rates are continuing to benefit from more members auto renewing as well as increased penetration of executive members who on average renew at a higher rate than the non-executive members and first year renewal rates which have improved a lot," Galanti said.

The retailer's gross margin for the first quarter was lower year over year by 49 basis points and excluding gas inflation lower year-over-year by 6 basis points. In terms of the core margin on their own sales in the first quarter, Costco's core margins were lower by 18 basis points, with non-foods slightly up and food sundries slightly lower year-over-year. Also lower year-over-year was fresh foods, which was the primary driver of the core on core being lower in the quarter.

"Fresh continues to lap -- to lap exceptional labor productivity and low product spoilage that occurred from the outside sales that began the year -- that happened a year ago in the quarter," Galanti said.

Galanti said the company's efforts to limit price increases is reflected in gross margin results that were “pretty good.”

"We've always said we want to be the last to raise the price and first to lower the price, recognizing there's a limit to what you can do based on these cost increases," he said. "Ultimately that may include us taking a little less markup. We saw inflation starting several months ago in a bigger way and continuing into this fiscal year. So I think it's going to continue, but hopefully we're getting towards the top and it'll start flattening out and subsiding. But we'll see."

The company opened eight stores in the first quarter and plans are to open a net 19 new units over the remainder of the year.

Issaquah, Wash.-based Costco operates 809 warehouses worldwide. The company, which is No. 4 on Progressive Grocer’s 2021 PG 100 list of the top food and consumables retailers in North America, also has e-commerce sites in the United States, Canada, the United Kingdom, Mexico, Korea and Taiwan.