On Thursday (3/7), Costco reported 2Q14 EPS of $1.05, $0.11 below our estimate of $1.16. The miss relative to our model came from four main areas: lower GPM ($0.05 of drag), higher (-$0.05), softer MFI growth (-$0.01) and higher pre-opening expenses (-$0.01). Overall for the quarter, sales increased 5.4% YOY, with comp sales increasing 3% led by a robust 4% increase in traffic. Meanwhile, MFI dollar growth was 4.2% YOY, or 7% in local currencies. Digging into margins, GPM (ex. MFI) fell 5 bps YOY to 10.53% - driven by a tough holiday selling season in non-food categories and weaker margins in fresh foods.
Importantly, core-on-core merchandise margins were only down 1 bp, despite COST absorbing 30-50 bps of pressure in both Hardlines /Fresh Foods with Food & Sundries/Softlines rising 5-20 bps.
Costco also reported core February SSS of roughly 4.3% on Thursday, despite being negatively impacted ~100 bps from bad weather. An important take from the call was managements’ indication that they would be repurchasing shares in 3Q14, after 5 straight quarters without any purchases. Overall, it pays to look ahead, as things get easier for Costco, with easier core compares for the rest of the year and as it cycles 8 bps of core GPM pressure in 2H14. We reiterate our Buy rating with a $129 price target on shares of COST, based on 23x our CY15 EPS estimate of $5.62.