How to play wholesale retailers like Costco and AutoZone

UBS US hardline and broadline and food retail analyst Michael Lasser joins Market Domination hosts Josh Lipton and Julie Hyman to discuss how to play wholesale retailers with a focus on Costco (COST) and AutoZone (AZO).

The analyst says the “number one” thing he’s looking for out of Costco’s upcoming earnings report is “very healthy growth in the membership fee income. That is a critical driver of the company's profit and loss statement. It represents about 50% of its total income. So monitoring that metric is important.” He adds he will also be watching for “how its margins are performing. What we look at is a key metric called core. On core gross margin, which is an indicator of how profitability on a particular item is doing this year compared to the same period last year that had been going up in the more recent quarters. It's been going down a little bit as the company invests to try and continue to offer value to its consumers.”

Lasser says “Costco is, without question, taking market share. Costco is taking market share from the vast majority of the players in the market, you know, that includes conventional grocery stores, specialty retail stores, mall-based retailers.” He says consumers are attracted to “the value quality equation” and opportunities to consolidate trips and time spent in stores. “Costco is uniquely well positioned to benefit from both of those trends,” he says.”

After Costco’s recent fee hike, Lasser says earnings will offer a look into retention, which he expects to remain strong “even if it does ease off ever so slightly,” and “how is [the company] using this additional pool of profits that it's going to be able to accrue to increase the value proposition to its consumers.”

AutoZone recently reported its fourth quarter earnings results missing expectations, but the stock is still up double-digits year-to-date. Lasser says, “The reason why the stock is up like it is is because the market is gravitating to sustainable growth stories. If we're sitting here a year from now, there's a lot of uncertainty over the next 12 months. We could walk through those factors. But what the market is saying is that it has a higher degree of confidence that AutoZone will continue to grow its earnings in light of how it's positioned and in light of the market that it serves. More so than other retailers.”

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This post was written by Naomi Buchanan.

Video transcript

We're looking at how to play wholesale wholesaler stocks and uh some of the other warehouse plays with the Yahoo Finance playbook.

Joining us now, Michael Lasser, U BS us, Hardline broad line and food retail analyst, Michael.

It's good to see you.

So when it comes to Costco here, um what are some of the highlights that you're looking for in that report?

So the highlights that uh we're expecting in the report are number one, very healthy growth in the membership fee income that is a critical driver of the company's profit and loss statement.

It represents about 50% of its total income.

So monitoring that metric is important also uh how its margins are performing.

What we look at is the key metric called core on core gross margin, which is a indicator of how its profitability on a particular item is doing this year compared to the same period last year that had been going up uh in the more recent quarter, it's been going down a little bit as the company invests to try and continue to offer value to its consumers.

Those are gonna be become some of the key metrics that uh the market's looking for, especially given that it already provided the heart of the sales that will report this quarter.

And Michael is Costco taking share here here in the US.

And if so from whom so Costco is without question, taking market share, Costco is taking market share from the a vast majority of the players in the market.

Um You know that includes conventional grocery stores, specialty retail stores, mall based retailers.

What is happening is the consumer A is attracted to the value quality equation.

It sells high quality products at inexpensive prices and B it is uh the consumer is consolidating trips and spend at particular retailers.

Costco is uniquely well positioned to benefit from both of those trends.

Um I'm also curious what we're going to hear in terms of the fee increase and I believe it was effective September 1st.

So it wasn't in the quarter that they're about to report, but maybe we'll get a little bit of a commentary on how things are looking so far in terms of whether it's affected memberships at all.

What do you think here are the two things to watch in regards to the fee increase.

Number one is how is retention in response to the fee increase?

And historically, Costco has experienced very stable and strong retention r uh trends in the 90% range.

We expect that to continue even if it does ease off ever so slightly.

And number two, how is it using this additional pool of profits that it's gonna be able to accrue to increase the value proposition to its consumers in many cases.

And oftentimes Costco will take the anticipated benefit, uh something like a fee increase and begin to lower prices even before that starts to roll into its income statement.

So, um how it's treating that, that PNL benefit will be important this quarter, Michael, another name I want you to take on Auto Zone.

Uh, report results this week looks like Q four.

Same store sales did miss stocks up though about about 20% this year.

What's your take on that name, Michael?

So the reason why the stock is up like it is is because the market is gravitating to sustainable growth stories.

If we're sitting here a year from now, there's a lot of uncertainty over the next 12 months and we could walk through those factors.

But what the market is saying is that it has a higher degree of confidence that AutoZone will continue to grow its earnings in light of uh how it's positioned and in light of the market that it serves more so than other retailers as a result.

Um It's multiple has expanded even as earnings have um you know, uh been ratcheted a bit lower more recently due to some currency headwinds.

We like Auto Zone.

We continue to believe that it's well positioned to outperform and Michael.

I wanna ask you a broader question.

As well because it affects many of the companies potentially in your coverage universe.

I, I'm wondering how you're thinking about sort of inventory management and pricing.

Right now, there are a couple of things that could affect that uh that are upcoming a potential port strike which could affect supply of goods and then there's the threatened increase in tariffs if former president Trump wins re election on a broad swath of good.

So, you know, how are you sort of thinking?

And I know this is very high level um because these are theoretical but sort of how are you thinking about how that could affect your coverage universe?

So by and large right now, retailers are very well managed from an inventory standpoint.

That's 12, there are a host of uncertainties in the next 12 months.

You highlighted a couple of them tariffs, uh the some uh some global supply chain, uh the tax situation because some of the tax cuts that were implemented in 2017, 2018 are set to expire at the end of the, the year.

Uh The overall uncertainty with the consumer being distracted from the election.

On the other hand, there are some positives.

Uh real wages are growing historically.

That's been a key driver of overall consumption.

Credit availability is becoming a bit more widespread and interest rates are coming down.

We take all of those factors into account what we believe is that there are risks and opportunities on both sides, we think you need to be selective within the retail sector.

As far as the specifics on the inventory situation.

Retailers have had a lot that's thrown at them in the last five years.

We remain confident that the large well positioned retailers like a Costco or Walmart Home Depot and Lowe's will be able to manage through it no matter what happens, Michael.

Always great to have you on the show and thank you for your time and those picks.

Good to see you.