When you join Costco (COST) – Get Free Report (or its rival Walmart’s (WMT) – Get Free Report Sam’s Club) you do so mostly because both warehouse club chains offer low prices and tremendous value. You might like the treasure hunt aspect of not knowing what might on the shelves, and you may enjoy some of the side benefits (like deals on home repairs, cars, travel, and a few other things,) but at their core, the two companies have built their business on selling goods cheaply.
It’s a fairly simple relationship that anyone can understand. You give Costco $60 for a basic Gold Star membership and it gives you access to its warehouses stocked with items that are barely marked up. Sam’s Club has a similar deal and, in both cases, the draw is that because you’ve paid to join, the company looks to offer great value, working hard to keep prices down.
In most cases, Costco looks to do everything it can to offer the lowest prices possible. That means leaning on vendors, placing huge orders, and sometimes even taking even less margin to make sure its prices are attractive.
That happens on nearly every item the warehouse club giant sells, but it’s not how Costco approaches its gasoline business.
Costco’s Cheap Gas Could Be Cheaper (Sometimes)
As gasoline prices fall, Costco does not lower prices at the same pace it raises them when prices are climbing. This allows the company to recoup some of the profits lost by doing the reverse when prices were rising.
Costco CFO Richard Galanti defended that practice during the warehouse club’s gas business during its second-quarter earnings call.
“I think part of that story has been thrown away because it seems that not only us, but the supermarket retailers and other discount retailers that operate large numbers of gas stations, they’ve been able to use it too. As prices went up or went — even went down a little bit, they didn’t go down as fast as perhaps they could have been, which gives us, in our view, an ability to make a little more and still be the most competitive,” he said.
Gas has actually been a profit center for Costco, but Galanti defends that because of what the company does with much of the money it makes selling gas.
Here’s How Costco Uses its Gas Profits
The CFO made it clear during the most recent earnings call that the current situation with its gas profits has allowed it to not raise prices in other areas inside its warehouses.
“As it relates to gas, for several quarters now, even beyond a year ago, we talked about the gas profitability for us, and we believe our competitors — other big chains of gas stations have made more in gas. And certainly, that’s helped us use some of that to continue to hold prices where we can on some things,” Galanti shared during the Q1 call.
That may not last forever, which the CFO openly acknowledged.
“Who knows what the new normal is? What we know is that not only is gas more profitable than it has been in the past, and like I said the same thing a year ago, will that change at some point? Maybe. We don’t know,” he added.
Galanti explained that the company keeps gas prices low enough to make it attractive to members and people driving by (who would have to join in order to fill up). The CFO believes Costco’s prices are low enough to win it more market share.
“As we’ve mentioned a couple of times, we’ve seen strong gallon sales, and we’re still taking market share. We — when the U.S. gallon sales are generally close to flat, we’re up in the 10% to 15% range in gallons,” he said. “So, we’re driving people into the parking lot.”
Gas, he shared, is a $30 billion business for the company, which does $220 billion in overall annual sales.
“So, that’s the big kahuna among all that stuff,” he said of the company’s gas business.