Categories: Business

Costco’s Cheap Gas Prices Are a Big Hit

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Costco

Wholesale is doing a booming business in gasoline by offering its members material savings that one Wall Street analyst has put at 37 cents a gallon. This comes at a time when prices have soared to a record of $5 a gallon.

Costco Wholesale (ticker: COST) could sell $30 billion of gasoline in its fiscal year ending in August, with about $25 billion in the U.S., according to Richard Galanti, the company’s longtime chief financial officer. The company sold a total of $17 billion of gas in fiscal 2021. Outside the U.S., Costco’s largest gas market is in Canada.

This year’s sharply higher gasoline sales reflect higher prices and volumes. The company is one of the largest gasoline sellers in the country, at about 17 million gallons a day, or roughly 5% of the U.S. market.

On Costco’s recent earnings conference call on May 26, Robert Nelson, the company’s head of investor relations, said that Costco has been seeing a percentage increase “in the high teens to low 20s” in gallons sold, against an industry average of 1% to 2% growth.

The warehouse club has become one of the country’s most successful retailers due to its rock-bottom prices on high-quality groceries and other staples. Gasoline is part of that value proposition.

 Nelson said Costco customers, who pay $60 a year for a basic membership, could save as much as $1 a gallon relative to service stations. That’s probably an extreme savings versus high-price retailers. An April survey by Barclays analyst Karen Short of 15 metropolitan areas found that Costco gas savings averaged 37 cents a gallon nationwide versus the various metro averages.

At a Union, N.J., Costco station this past Thursday, the savings were less, at 16 cents a gallon. Costco was selling regular gas for $4.839 per gallon, against $4.999 at local branded service stations such as Valero and Sunoco.

“Gasoline is an important, but not the only driver of Costco’s loyalty and traffic growth,” Greg Melich, a retailing analyst at Evercore ISI, told Barron’s in an email. Gas could account for 14% of Costco’s sales this year, up from 9% in fiscal 2021.

The company’s shares, at $463, have come under pressure in recent weeks along with those of other retailers, falling 24% from an April peak of $612. But the stock commands one of highest price/earnings ratios among big retailers, at 38 times projected earnings in its current fiscal year, double the multiples of Target (TGT) and



Walmart

(WMT).

The high P/E ratio reflects Costco’s continued strong sales growth, high membership loyalty and a wide moat around its business due to ultralow prices. The company scored during the pandemic when consumers stocked up on essentials, and it has maintained that momentum with members now eager for savings as inflation crimps household budgets.

“Gas is the ultimate high-volume item that turns very fast,” Costco’s Galanti tells Barron’s. “For every 100 people who fill up their tanks, about 50 come in to shop. We recognize that most of them aren’t incremental shops, but even if it’s one or two, it’s meaningful.”

The average gas station in the U.S. gets a fuel delivery every eight to nine days. “We turn our gas almost daily. In fact, some gas stations fill up three or four times a day,” Galanti told Barron’s.

This means tanker trucks need to come to Costco stations on average of once a day—and more often for high-volume stations—to refill underground tanks. A gasoline tank at a service station typically holds 30,000 to 40,000 gallons. Galanti said some Costco stations have six bays of four pumps each. When Barron’s visited the Union, N.J., Costco station, a tanker truck was unloading gas while members lined up at the pumps.

Costco’s membership renewal rates continue to rise and hit a record 92% in the latest quarter in the U.S. and Canada. It has 64 million members.

“Costco’s extreme value offering is more appealing than ever amidst widespread inflation, with an upper-income core shopper who can afford to spend,” Melich wrote recently. He has an Outperform rating and $540 price target on the stock.

Costco had 636 gas stations globally at the end of its latest fiscal year. In the U.S., about 90% of its 574 warehouses have gas stations. The average Costco gas station gets well over 2,000 customers a day who buy an average of about 12 gallons per visit.

If a member buys 500 gallons of gas annually, that’s a saving of $175 at a 35-cents-a-gallon gap relative to service stations. Even if a member buys 250 gallons a year, gas alone can make a $60 annual membership worthwhile. “If you live in an affluent suburban enclave with two gas stations, you save more since they really are sticking it to you,” Galanti says. He adds that Costco gas is the same quality—Tier One—as the product at branded service stations.

Costco, contrary to some speculation, doesn’t sell gas below cost. Galanti says the margin is below the company’s overall gross margin which stood at about 10% in the latest quarter. Scot Ciccarelli, an analyst



Truist
,

has estimated that Costco’s gas margins are in the mid-single digits.

Costco has had some of the strongest results among large retailers, as consumers flock to its stores for rock-bottom prices on groceries, gasoline, paper products, clothing, wine, books, and unexpected bargains. That creates a treasure-hunt atmosphere.

Costco’s U.S. same-store sales in its quarter ended in early May were up nearly 11% excluding gasoline, and 16.6% including it. By contrast, same-store sales at Walmart and Target rose around 3% in the latest quarter. Costco’s earnings per share were up 11% in the period.

Costco is able to turn a profit with probably the industry’s lowest gross margins. Walmart’s, in contrast, are around 25%. This reflects Costco’s lean cost structure, warehouse format, and minimal shoplifting. Costco makes the bulk of its profits from membership fees, with the stores running at just a 1.5% operating profit margin.

Costco’s low markups—nothing is marked up more than 15% above cost — make its prices almost impossible for rivals to undercut profitably. That has created one of the best business models in the retailing industry.

Write to Andrew Bary at andrew.bary@barrons.com

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