Costco Wholesale Earnings Call Nuggets: Inflation Outlook and Price Investments

Costco Wholesale Corporation (NASDAQ:COST) recently reported its third quarter earnings and discussed the following topics in its earnings conference call.

Inflation Outlook

Deborah Weinswig – Citi: Can you talk about your frequency which was obviously very strong in the quarter and absolute on a relative basis? Can you talk about any unique drivers behind that?

Richard A. Galanti – EVP and CFO: Not really. I mean, we’re not doing anything different other than continuing to be aggressive on pricing and if you haven’t tried our rotisserie chicken, that’s the new hotdog in terms of $4.99 chickens. We haven’t changed – there’s not been a lot of difference year-over-year in any of the MVM mailers, the coupon mailers. So, not really. We certainly are getting our share of free press out there, whether it’s the late night talk shows or the morning business shows. So I think we certainly are getting a lot of – but that’s all anecdotal of course, but there’s nothing specific that we have done different of late.

Deborah Weinswig – Citi: And then can you also discuss your inflation outlook as it stands right now?

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Richard A. Galanti – EVP and CFO: Talking to the buyers, there’s not a lot of anticipatory inflation with the exception of some aspects of protein. They continue to see inflation in some of those items, beef, poultry and pork, some of the, what we call, limited resource commodities like nuts because of increased world demand with the increasing middle-class, if you will. Those have spiked up. With those few exceptions, there is not a lot. I think to-date, we are – if you use as your benchmark the LIFO calculation which looks at what our U.S. inventories by item at cost were and how those costs have changed from the beginning of the year to now, again, it’s ever so slight credit in each of this quarter and the last quarter. I think together it’s – if the 100.00% was the base as of the beginning of the fiscal year, as of Q3 end, it was 99.41%, so 0.6% lower cost inflation. Now, that’s again – that’s one measurement that’s easy to look at because it’s basically our U.S. LIFO inventory accounts. But that was discernibly different than a quarter ago. But we overly see a whole lot of trend upward beyond those smaller areas that I mentioned. I think gas is always (there), who the heck knows…

Deborah Weinswig – Citi: And then on the executive membership style, which has obviously done incredibly successful in the U.S., beyond Canada, the U.K. and Mexico, how should we think about the growth there?

Richard A. Galanti – EVP and CFO: Well, we continue to look at it in all countries. I think we seem to like it. It works for us. Generally speaking, we like to have a core number of locations there and start off with some small number but more than one or two of services that we can provide under the executive member format; the member services where the executive members in some cases get a better deal on some of those services. So, we’ll continue – we continue. I would guess over time we’ll continue to roll it out to other countries. I mean, again, the $13.3 million, I think, all but about $400,000 of that are U.S. and Canada, which, of course, are – U.S. and Canada is probably roughly 80% of our Company in terms of sales or locations or what have you and well over 95% of the executive member base, but that’s because it started here.

 

Price Investments

John Heinbockel – Guggenheim Securities: So, Richard, a couple of things. The price investments, is there more of skew toward consumables or no? It’s more broad-based than that?

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Richard A. Galanti – EVP and CFO: It’s more broad-based than that. Given just the sheer volume of items what we need to make share is we don’t want to spread it out. You’ve got to be wow, if you will, on items and not just spread it across all categories and all items. So, we try to do a pretty good job at that. But it’s spread among categories. Little tongue and cheek talked about the chicken. I mean, as protein prices go up, our costs go up and we’ve been very successful, we think in driving sales and if we can get you in – go to the back of the location and give that great chicken for $4.99, you’re going to shop doing other things. But it’s across the board…

John Heinbockel – Guggenheim Securities: So, the idea – no matter what department you’re talking about the idea here is not so much where you can get your costs down, but where you can make it clear on production on the customer perceptionalized.

Richard A. Galanti – EVP and CFO: Sure. I mean, ultimately, it’s an art form and it’s merchandising and it’s across the board. Sometimes we work with vendors and sometimes we rotate in and out. It’s not unlike what we do historically on the fence, you’re always going to see – or end caps, you’re always going to see some – and try to create excitement as you walk down those larger aisles down the main aisles.

John Heinbockel – Guggenheim Securities: Do you think – as you guys look at it, do you think the price gap has changed or widened versus your various competitors or no, it’s about what it was?

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Richard A. Galanti – EVP and CFO: I think it’s been pretty similar over the last few years. We don’t see any dramatic change in it. If anything, we tend to sincerely play offense irrespective of what’s going on out there. I mean, you’re always going to see be it our direct competitors of Sam’s and BJ’s or other category dominant retailers, you’re always going to see items and departments but for the most part, when we do our weekly by location market baskets on key competitive items, those ranges in our view of our competitiveness is pretty similar to what it has been, if not, a little higher, a little better.

John Heinbockel – Guggenheim Securities: More favorable to you.

Richard A. Galanti – EVP and CFO: Yeah. But I’m talking to (indiscernible)…

John Heinbockel – Guggenheim Securities: And then, just two last things. Is there about $30 million left of incremental benefit on the membership fee increase, is that about the residual number?

Richard A. Galanti – EVP and CFO: It has a three in it, it’s a little higher than $30 million. It starts with a three, but it’s higher than $30 million.

John Heinbockel – Guggenheim Securities: And then lastly, when you look at Kirkland, where are you roughly now with SKU count and do you think as a percent of club SKU count, that inevitably goes higher and I know you don’t want to force it on people, but obviously there is – you continue to find value-added items. Do that just go higher over time as a percent of total SKU count?

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Richard A. Galanti – EVP and CFO: Yes, absolutely. I think it’s still in the low to lower mid-20s, but it keeps going up incrementally. Part of that is the increased penetration of some of those items overseas where whatever extreme value we are, it’s even more extreme on those kind of things. I mean, we have items that do $2,000 and $3,000, and $4,000 of, (call it), position in the U.S. that do five and 10 times that in some of the Asia countries. It’s simply because it’s a great value on great stuff. And we can even be more extreme over there versus brands. So, yeah, we continue to look at different areas and we’ve – this past year I know we put it on some women’s exercise apparel activewear which has been very successful. We continue to put it on – I know we have several men’s summer items, whether it’s shorts, performance polo shirts, and so – all those types of things. So it’s not just – it’s food and non-food. I don’t see any discussion of putting it on a television or anything anytime soon, but certainly there is a lot of categories. All the low-lying fruits; paper goods, water, those are all done. But probably the lowest lying fruit in the last few years was probably the disposable diapers. But there’s lots of things; it always amazes me when individual food items, the cashew clusters or something innocuous like that is a $15 million item and $25 million and $30 million later. All said, you’ve got those types of things out there. So, I think it’ll scale slowly through the 20s and upward. But it’s not like we have a conservative effort to try to get to a number next year.