Costco Battles a Tough Economy - Analyst Blog

Costco Wholesale Corporation ( COST ) continues to be a dominant retail wholesaler based on the breadth and quality of merchandise it offers. The company's strategy to sell products at heavily discounted prices has helped it to remain on a positive growth track amid beleaguered economic conditions as cash-strapped customers continue to see it as a viable option for low-cost necessities.

Having delivered comparable-store sales growth consistently, Costco is well positioned in the warehouse club industry.

Comps Remain Positive

The U.S. economy has been grappling with the financial crisis, which has gradually engulfed the global market, with ripple effects spreading panic. Amid this turbulent environment, Costco has been moving on and keeping its positive rhythm.

Since January to November 2011, Costco has consistently registered comparable-store sales growth reaching a low of 8% in February and touching a high of 14% in June, witnessing an average growth of approximately 11%. This is much better than its competitor Target Corporation ( TGT ) that witnessed an average comparable-store increase of 3.4% in the same period. Costco experienced comparable-store sales growth of 9% both in October and November.

What Drives Growth

A differentiated product range enables Costco to provide an upscale shopping experience to its members, resulting in market share gains and higher sales per square foot. Moreover, the company continues to maintain a healthy membership renewal rate.

Costco also remains committed to open new clubs in domestic and international markets. The company's diversification strategy is a natural hedge against risks that may arise in specific markets.

Healthy Quarterly Results

Consumers seeking discounts started flocking to warehouse clubs leading to improvedsales of discretionary items. Consequently, Costco witnessed double-digit growth in the top line that led to an increase in the bottom line. The company's international operations have been the major driver.

Costco's first-quarter 2012 earnings of 80 cents a share met the Zacks Consensus Estimate, and rose 12.7% from 71 cents earned in the prior-year quarter.

The warehouse retailer'stotal revenue, which includes net sales and membership fee, climbed 12.4% to $21,628 million from the prior-year quarter. Net sales jumped 12.5% to $21,181 million, whereas membership fee rose 7.5% to $447 million. The Zacks Consensus Estimate for the quarter was $21,293 million.

Costco's comparable-store sales for the quarter rose 10%, reflecting a comparable sales growth of 10% at its U.S. locations and 11% at its international divisions. The results were favorably impacted by rising gasoline prices and strengthening of foreign currencies.

Challenging Economy and Competition

The economy is still not out of the woods, and whether 2012 will mark the resurrection is tough to say, unless some concrete steps are taken to avoid another cliff fall. Cuts are deep and wounds not healed. Each and every company is vying to survive the downturn, and trying every means to reach the helm.

Costco faces stiff competition from Target and Sam's Club, a division of Wal-Mart Stores Inc. ( WMT ), which follows a similar business modelthat pushes through high volumes of merchandise at low prices in membership-only warehouse clubs. Thus, aggressive pricing to gain market share and drive traffic amid stiff competition, may depress sales and margins.

Moreover, the company's customers are sensitive to macroeconomic factors including interest rate hikes, increase in fuel and energy costs, sluggishness in the housing market, and high unemployment and household debt levels, which may affect their spending.

Wrapping Up

After the Black Friday sales blast, there is skepticism in the market of whether the success of weekend sales will be replicated during Christmas and New Year, or whether consumers who have now become more rational about spending will tighten their purses. However, the efforts of retailers to convert store traffic into business cannot be decried as they are trying to lure customers. But it definitely remains a wait-and-watch story as to who emerges successful in wooing consumers in this distressed economy.

Given the pros and cons, we maintain our long-term Neutral recommendation on the stock. Moreover, Costco holds a Zacks #3 Rank that translates into a short-term Hold rating, and correlates with our long-term view.

Costco currently operates 596 warehouses, including 433 in the United States and Puerto Rico, 82 in Canada, 32 in Mexico, 22 in the United Kingdom, 9 in Japan, 8 in Taiwan, 7 in Korea and 3 in Australia.

COSTCO WHOLE CP ( COST ): Free Stock Analysis Report

TARGET CORP ( TGT ): Free Stock Analysis Report

WAL-MART STORES ( WMT ): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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