The Surprising Deal That’s Fueling Costco’s Growth

Investors are very lenient when it comes to stock Costco Wholesale (NASDAQ: COST). While it fell last week after reporting just 1% year-over-year revenue growth, it’s still up 34% year-to-date, well outpacing S&P 500.

Costco has built its reputation over several decades to become so deserving of that unwavering investor confidence. It is reliable for consistent growth and the market is not willing to cut it too much on a quarter to quarter basis. Investors see a long opportunity ahead and expect sales to increase. And many of these already come from a surprising source.

Happy members go digital

Costco members love shopping through the company’s huge warehouses. But these days, every major retailer has some kind of digital presence, including Costco.

It doesn’t sell on its website everything it sells in its warehouses, such as fresh produce, but it has a healthy range of products and more large items, such as appliances, than it sells in its stores.

Total revenue rose just 1 percent in the fiscal fourth quarter (ended Sept. 1) and was below analysts’ expectations. But sales in the e-commerce segment increased by 18.9%. And this was no accident. E-commerce has grown at double-digit rates for three consecutive quarters after entering negative territory last year.

Data source: Costco quarterly reports.

E-commerce traffic, conversion rates and average order value increased year-over-year, and management said the segment was driven by “growth in sales, item mix and fulfillment productivity.”

Shipping the Costco way

Interestingly, Costco reported similar volume and average ticket trends that it has had in recent quarters: a 0.9% decrease in average ticket size and a positive 6.4% increase in volume. That means people shop more often but spend less on travel. So far, that has involved more food and fewer high-priced items. But that’s not how it played out in the fourth quarter.

Bigger-ticket items underperformed with high inflation, but in the fiscal fourth quarter (ended September 1), saw a nice rebound. It was food products that took a step back after rising last year. Appliances, furniture and jewelry grew by double digits in the fourth quarter. This is where e-commerce comes in.

Costco has its own logistics business to handle the large volume of deliveries — more than 4.5 million products in the past year, up 29% year over year.

The story continues

More members are finding value by buying more expensive items online, which was a problem when customers stopped by, but is proving to be a strong driver of e-commerce growth. They also enjoy the company’s treasure hunt offers, which are constantly changing on the site. And management is figuring out how to make the segment more profitable.

Since Costco is responsible for the logistics costs of e-commerce sales, which are not an additional expense to sales from its brick-and-mortar warehouses, and cannot pass all the expenses on to customers and still offer the same prices, the e-commerce business is more expensive to run , especially with bulkier items such as furniture and appliances. Management mentioned assembling orders and packing them, which requires employees, is usually the biggest expense for any business.

It’s a similar story with buy online, pick up in store (BOPIS). This is not cost-effective for lower-priced merchandise, but it is for certain larger items that would otherwise require shipping and handling charges. The management said it has started offering TVs through its BOPIS program with a positive response. They are still rolling out more e-commerce features and services, figuring out how to generate sales at a profitable level in this new omnichannel world.

Are they coming?

Although Costco has offered some e-commerce for years, management feels it is just getting into the technology. There’s a lot to explore here, and the company could go into e-commerce and offer other tech services in a Costco kind of way.

Meanwhile, expect online sales to play a larger role in overall revenue in the near future. As interest rates drop and members start spending more on high-end items, they are more likely to take advantage of Costco’s impressive logistics services and lower prices.

The company should also benefit from a boom in the real estate industry. As people buy homes and return to home improvement, they will find value in Costco appliances and furniture and make those purchases online.

Investors shouldn’t worry about Costco’s fourth-quarter earnings miss and should brace themselves for better days ahead, boosted by a robust e-commerce platform.

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Jennifer Saibil has no position in any of the shares mentioned. The Motley Fool has positions in and recommends Costco Wholesale. The Motley Fool has a disclosure policy.

The Surprising Deal Driving Costco’s Growth was originally published by The Motley Fool