Price cuts and freight costs pressure Costco's margins, sending its shares lower

  • Costco Wholesale reported third-quarter results that topped analysts' estimates.
  • Price cuts and higher freight costs weighed on the warehouse club operator's gross margins.
  • The retailer has aggressively cut prices in order to lure back customers to its wholesale supermarkets.

Warehouse club operator Costco Wholesale reported third-quarter results that topped analysts' estimates, but price cuts and higher freight costs weighed on its gross margins, sending its shares lower in extended trading.

The retailer has aggressively cut prices in order to lure back customers to its wholesale supermarkets, following Amazon.com's foray into brick-and-mortar retail with the acquisition of Whole Foods Market last year.

Gross margins slipped 46 basis points to 11.05 percent as the company also stepped up efforts to provide same-day and two-day delivery through delivery service provider Instacart and invested in packaging equipment.

Still, the company said an increase in membership fees implemented earlier this year and customer gains from the closure of more than 50 Walmart Inc's Sam's club stores could help offset pressure from rising freight and labor costs.

Customers shop at a Costco store.
Getty Images
Customers shop at a Costco store.

Costco also said effective June 11, starting wages for its U.S. employees will be raised by $1 to $14 and $14.50 an hour.

This is expected to result in higher pretax cost of $110 million to $120 million annually, with its fourth quarter taking a $25 million hit.

"The concern is probably around the gross margin and wage increases," Edward Jones analyst Brian Yarbrough said, pointing to the stock's 2 percent fall in extended trading.

However, Costco's moves to invest heavily in its online and delivery services helped drive a 14 percent growth in revenue from membership fees and a 35.5 percent rise in e-commerce sales in the third quarter.

Sales at established stores, excluding fluctuations in gas prices and currencies, rose 7 percent in the reported quarter, beating analysts' estimate of a 5.4 percent rise, according to Thomson Reuters I/B/E/S.

"Costco continues as the retail poster child for consistency, with virtually every metric reflecting strength," Moody's retail analyst Charlie O'Shea said.

Net income attributable to Costco rose to $750 million, or $1.70 per share, in the quarter ended May 13 from $700 million, or $1.59 per share, a year earlier.

Excluding items, the company earned $1.70 per share, a penny above the average analyst estimate. Total revenue rose 12.1 percent to $32.36 billion, also beating estimates.