Costco Wholesale Corporation (COST) Earnings Call Transcript & Summary

Hi, everyone. Hopefully, you can see me. I'm kind of welcoming you into my home, into my world here. I'm Simeon Gutman, Morgan Stanley's Hardline/Broadline food retail analyst, and it is a very distinct pleasure to welcome the team from Costco. With us, Richard Galanti, CFO; Bob Nelson, SVP, Financial Treasury, IR. I hope I got that right. And in the room, 2 folks from their IR team, David Sherwood and Josh Damon. So we're going to get right into the fireside chat. I believe the audience has access to the webcast to ask questions, and I'll be monitoring, and I could ask some to Costco that way. So thank you for being with us Costco team and Richard. I guess, can we start asking a high-level question. Biggest surprise during the COVID environment so far for Costco?

Well, I think there are a few of them. I mean, when COVID was starting up in mid-March, the concern was in the last 10 weeks, not 6 weeks. And of course, it's changed a lot. I think the first surprise was, we're a company that has about 7,500 people in our headquarters in various buildings here. And we went from essentially all working from the office to almost all working from home. And it took a couple of weeks, but we got it done. And I think the technology today, it has surely helped a lot of us. But that was the #1 surprise. The other -- probably the biggest surprise from a positive standpoint is the strength that we've seen over the last 4 or 5 months, June through October, sales results, as you've seen. After April and May, which were down, bigger baskets, less frequency or negative frequency at some points. Again, we're certainly still driving business because of food and sundries and fresh foods and health and beauty aids and like them being essential, so people are coming in. But we were planning like many out there, a possible worst case that what happens with discretionary nonfood items and bigger-ticket items as we go into lawn and garden, patio and furniture and bigger-ticket items. And again, to our pleasant surprise, we saw a lot of that pick up. And looking back, why people, I think, had a little bit of COVID fatigue. People weren't buying tickets to concerts, weren't going out to eat, weren't getting on airplanes or cruise ships or going hotels. And they're spending that money and spending it around home things. And one of the good things about our business, as you know, is we're an item business, and it's relatively easy to pivot a little bit in that genre. So now as some of those things picked up, we were scrambling first positive goods where we thought we had cut back orders in March, April, when we come into June and July, and they're scrambling for extra patio furniture and the like. And certainly added SKUs for the whole, whether it was small electrics, all types of food processors and mix masters, domestics, you name it, people are buying things for their home. So I think that also was a surprise to us, a pleasant surprise. And that just continued through October. Beyond that, of course, we, like many companies went out and made sure -- assuming there was going to be a worst case, how does that change our capital needs as it relates to lower inventory turns and perhaps a merchandise that we'd have to hold -- seasonal inventory we might have to hold. Again, we went the other way to have a scramble for more. But back in March, April, [indiscernible] we had estimated we might need as much as $1 billion just for seasonal things that we committed to, and we are going to honor those commitments, but we might have [indiscernible] following year seasons. And so we [indiscernible] you've seen our numbers over the last 2 fiscal quarter ends where our payables ratios [indiscernible]. Those are the main things. I think there continues to be some shortages on some essential goods, although you just mentioned there's one that's not a shortage anymore before the call started. But again, we've expanded some of our suppliers in some cases. There are many items that we might be doing. But we are 30% or 40%, we could be up 100% if there's more availability, whether it's certain electronics items or certain paper goods or cleaning -- sanitizing items. But we're all [ arranged ] on everybody, and we're getting our fair share of that stuff. And again, I think we've expanded some of the relationships. And overall, that's what the last 6 or 8 months have been like. The only people we have brought back in a big way is our buyers. We have about 20% of our 7-plus thousand people on campus. And many managers like us, we've been around, frankly, just more real here than there is at home. And my comments so far, it's worked. And the view on the buying is while we were getting things done at home and keeping the shelf stocked from a collaborative and a creative standpoint and [indiscernible] standpoint, Craig, our CEO, and Rod, our Head of Merchandising, felt it's important to be a little bit more [indiscernible], even if it's in a distance. And so -- and that's worked well so far. We do the safety protocols and wear the masks and limit the number of people in the room and constantly sanitizing everybody.

Great. And I remember that conference call, I forget if it was late March, right before we understood the severity of what we're dealing with, you were talking how the purchasing, I think, it was outdoor furniture kept coming briskly, and we were still puzzled how that was happening. But you may have answered partially my next question, which is the greatest operating challenge during this pandemic, and whether it's in stock or managing people. But if you can just isolate what's the biggest challenge? And then what's gone easier than you expected thus far?

Look, I think the greatest challenge is always people with safety issues, both our own employees and our members. As you know, we got a little bit of notoriety when on May 4 we instituted a mass policy -- a mass requirement policy for our members. Not everybody felt that was appropriate. Fortunately, over the next few months, that changed dramatically with other companies out there requiring the same. So we feel good about that for that. I think the challenge dealing with your employees and from our CEO down to the newest hourly employee, we're all dealing with COVID and the anxiety related to it and different people have different personal issues at home they're dealing with, whether it's elderly parents or someone else in their family got sick or kids not going to school, so I think we've done a good job of managing through that, and we learn as we go along.

[indiscernible] supply chain.

Yes, operationally, supply chain, again, yes, it rains on everybody. We've got our share of things. We think in some ways, we're able to pivot a little more quickly and to bring in different items or alternative items and we certainly -- if you look at the supply chain from Asia, and while there's still some shortages, partly because of the higher demand in electronics and chips and everything, sales are way up, but they could be even more up if there is -- in some cases. What's that?

If we have more product.

Yes, if we have more product. There are some issues from other parts of the world with textiles and apparel. And again, textiles, there's -- we've seen strength in things from all the [indiscernible] and things for the home. And -- but again, and maybe we were carrying a certain size of something on dry grocery or cleaning supplies. Now we're selling every size that's made in every brand that's offered. And so, we've expanded our supply network a little bit. And again, overall, you're still going to see limits on certain items. The protein area has come back very strongly. There were some limitations that we and others put on beef and pork and poultry, both fresh and refrigerated and frozen. I think it was looked -- at a time there was limited 3 items from fresh that you can get 3 giant packages of briskets or 3 different things, but that's behind us now. And I think, again, from a supply chain standpoint, I think that we did a good job of first of all, when everybody thought it was -- originally it was going to be worse and demand is going to be down, there's some people out there that just call the vendor and say, we're not -- cancel the order. I don't care if you already made it, not everybody. And some retailers or companies couldn't -- didn't have the capital to do it. We've honored all our orders. We worked with vendors to reduce orders of products that hadn't been made perhaps yet. But beyond that, I think we did a good job of continuing that good relationship and the trust that we have with our suppliers.

So your sales growth on a percent basis has been among the strongest in retail, probably in the top 5 of the companies we cover. On a dollar basis, it may be in the top 3. Can you talk about which categories -- based on your analysis, which categories and/or competitors, I'm thinking segments, whether it's grocery, or some of the apparel or electronics or home furnishing, where do you think you've been taking share? And then do you think you've lost ground in any segments? So just talk about what are the strengths and sort of the weaknesses in terms of categories and share?

Sure. And again, I think we've been fortunately well positioned through this thing. Certainly, we and supermarkets are taking food business from restaurants. And that starts the process of getting you into the store, if you will, as well. Again, I think the surprise was in terms of the nonfood categories, we're taking from traditional retailers, we're taking from the malls. Malls were having some challenges but -- for COVID but certainly, in the past 6 or 8 months, that's been a very big challenge. There's been some brands that have been willing to sell us. Not a huge change, but in tough times, sometimes when it's set out there and given our sales strength, we've been able to benefit from that as well. I really can't want to be [indiscernible] but I can't think of anything where we have lost market share. Certainly -- particularly in the last few months, our shopping frequencies have come back and the basket is bigger, implying that there's market share. When we look at, what was it, NPD data, the industry data by product and category, we're doing pretty darn well against that. And again, I think it starts with getting into the building. I think the safety protocols, the fact that our buildings are relatively voluminous or big, it's -- you feel a little safer when it's a 12-foot aisle and a 24-foot ceiling than when it's 8-foot aisle and 16-foot ceiling compared to supermarket, it's not to say we're [indiscernible] supermarket as well. But I think that there has been a sense of comfort and safety that has probably allowed our frequency to improve in that regard.

Okay. I want to switch to membership. So a few years ago, we talked about the different cohorts of members that Costco has and that you're seeing increased members from, I think, some of the younger cohorts and that the progression of spending was normal, but you were hoping or waiting for these millennials to start moving through sort of the curve. Can you talk about -- has anything changed around the spending habits by the cohorts? I mean, I guess it's safe to say all of them probably have increased, but anything different than you would have expected?

Yes, when you look at that curve from 18 to 25-year olds all the way up to 75-plus-year olds, it's a curve where the sweet spot is still in the 40 to 55 year old range. And when we look at that chart, 10 or 15 years ago, when it was -- whatever it was before millennials, Gen X and millennials and now whatever it is Gen Z, we're seeing the same type of trends in terms of how many -- what proportion of people are signing at. And that's where we're getting our share. Now logic would say, if they take that as people, not just because of COVID and people moving back home with their families and stuff. But overall, millennials perhaps staying at an apartment little longer, moving to a smaller house, have [ 0.2 ] less kids or whatever the statistics are out there. Again, that rings on everyone. Again, I think that we're fortunate that we have a unique product and selection and value proposition. And I remember 6 or 8 years ago when people would ask on the calls, how are you going after millennials, one [indiscernible] moment, I said where else you get great value on organic [indiscernible]. And the reality was is we turn around, and we're the largest seller of organic foods in the world. And whether it's -- electronics is strong for everybody right now, but we've expanded not just with tablets and laptops and not just with the TVs, but with audio because people are at home. And so I think that our ability to move our mix around or an item [indiscernible] of the business, I think that's a little bit of thing that helps us on the way.

And then that brings me towards, I guess, retention, which it seems like Costco has become an even bigger part of household spend and maybe their lives at the moment. Why wouldn't -- why shouldn't we expect to see retention go up to even all-time higher levels than we're currently used to?

[indiscernible] Look, we're optimistic. We don't predict or project what it's going to be. It is -- in the last couple of quarters, it's been at an all-time high percentage point. Prior to that, it ticked up a 0.5% in the previous quarter. And so far, we feel pretty good. Now what are the things right now that are helping or hurting it. We're -- since COVID, we're not -- we don't have somebody walking around to people standing in line to check out, to scan their card, what we call an eblock to say, "Hey, you could have upgraded it to the executive member and would have more than paid for itself." Or a higher percentage of people are now signing up online than coming to the membership desk. Still a lot of people at the membership desk, but that percentage is reduced. We're better getting you to sign up as an executive member, the person that we are online [ in that regard ]. And so those are some things that arguably are hurdle a bit, although, again, the last 2 quarters [indiscernible]. Offsetting that is, just like through the 16 years with Amex and now the 3 or 4 years with Citi/Visa and alternative a similar arrangement in Canada, we're getting an increase in the higher percentage of our members to be automotive. And let's say, so that helps too. But more importantly, if we can get you to become an executive member and we get you that -- the credit card, each of those are sequentially -- you spend more, you come more frequently and you [indiscernible] more frequently. So aside from we're wonderful merchants and we've got great products and values -- and I think what we have found over time, I remember a few [indiscernible] analysts would report 8 or 9 years ago that 20% of U.S. Costco members had Amazon Prime. A year later, it was 32%. A year later, it was 48%. And at the end of the day, I think we've all learned that they're not mutually exclusive. They both perform a good function. And so we feel good about what we've done so far and we're continuing to do that [indiscernible] value. Now omnichannel has helped in the way we do it. We're not everything to everybody, but we do have with -- primarily with our Instacart partner, but also a couple of smaller ones elsewhere, same-day fresh. We are doing a 2-day dry grocery out of most of our 19-or-so business centers, over half of them on 2-day grocery, dry grocery. And we're still reluctant to do the buy online and pickup in store other than a few bigger-ticket, small-sized items, like jewelry and all. But at the end of the day, all those things have been exacerbated to the high end with COVID. And some of that will stick as well. But we seem to be -- when asked the question that last year, our e-commerce was about 5% of sales in fiscal '19 and fiscal '20, it was what about

6 for the year but...

6 for the year but annualizing at 8 since COVID, if you will, add to that Instacart, which we don't include in e-commerce because they're coming into our store -- on our warehouse to buy, that's another whatever, $2 billion or $3 billion. I mean, it's meaningful, but it doesn't have to be 35% or 25% or whatever everybody thinks. And so I think it's a model that has worked for us. We're not -- hopefully, never sticking our head in the sand and we're never going to do something, but at this juncture, we're not looking to do some of the things that others are doing.

I want to ask about profitability. So your model has always been different than others. And I guess, there's been a lot of debate over where margins for retailers can go. I don't know if you want to opine on that broadly, but just speak directly for Costco, there's been higher costs, operating costs inside the warehouse, but obviously, more volumes, but what -- just curious your thoughts on the topic broadly?