The surprising company driving Costco’s growth

Investors are very forgiving when it comes to stocks Costco Wholesale (NASDAQ: COST). Although it fell last week after only a 1% year-over-year increase in sales, it is still up 34% year to date, easily better than S&P500.

Over decades, Costco has built a reputation that deserves its rock-solid investor confidence. It’s reliable for steady growth, and the market isn’t willing to send it down too much on a one-quarter basis. Investors see the long-term opportunities ahead and expect sales to pick up. And much of it already comes from a surprising source.

Happy members go digital

Costco members enjoy shopping at the company’s massive warehouses. But today, every major retailer has some form of digital presence, including Costco.

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

Total revenue rose just 1% in the fiscal fourth quarter (ended September 1) and fell short of analyst expectations. But sales in the e-commerce segment rose by a surprising 18.9%. And that was no fluke. E-commerce has been growing by double digits for three quarters in a row, after entering negative territory last year.

Data Source: Costco Quarterly Reports.

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

Deliver the Costco way

Interestingly, Costco reported similar trends in average ticket and volume levels as in recent quarters: a 0.9% decline in average ticket size and positive volume growth of 6.4%. This means that people buy more often, but spend less per trip. Until now, that has meant more groceries and fewer expensive items. But things didn’t go that way in the fourth quarter.

The more expensive products underperformed amid high inflation, but showed a good recovery in the fourth quarter of the financial year (ending September 1). These were the groceries that took a step back after the strong increase last year. Appliances, furniture and jewelry all rose double digits in the fourth quarter. That’s where e-commerce comes into the picture.

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

The story continues

More and more members are finding value in purchasing higher-priced items online, which was a problem when customers were reluctant, but it’s proving to be a strong growth driver for e-commerce. They also enjoy the company’s scavenger hunt deals, which are constantly changing on the site. And management is figuring out how to make the segment more profitable.

Because Costco is responsible for the logistics costs for e-commerce sales that are not an additional cost to sales in its physical warehouses, and it cannot pass all costs on to customers and still offer the same prices, the e-commerce company may be more expensive to operate , especially on larger objects such as furniture and appliances. Management cited picking and packing orders, which require employees, which is typically the highest expense for any company.

It’s a similar story with buy online, pick up in store (BOPIS). This is not cost efficient for cheaper goods, but is for certain larger items, which would otherwise require freight and delivery charges. Management said it began offering TVs through its BOPIS program, with positive response. The company is still rolling out more e-commerce features and services, figuring out how to generate revenue at a profitable level in this new omnichannel world.

Is there more to come?

Although Costco has offered e-commerce for years, management feels like it’s all about technology. There’s a lot to explore here, and the company could enter e-commerce and perhaps offer other tech services in a Costco-like way.

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

The company should also benefit from a surge in the real estate sector. As people buy homes and start making home improvements, they’re finding value in Costco’s appliances and furniture, and they’re making those purchases online.

Investors shouldn’t worry about Costco’s fourth-quarter revenue loss and should prepare for better days ahead, boosted by a robust e-commerce platform.

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

The surprising company driving Costco’s growth was originally published by The Motley Fool