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CostCo (COST)
Why are CostCo's Profits Down?
In February, CostCo warned investors that their Q2 profits would be "substantially below" expectations. As a retailer, this made sense at the time. However, because they provide consumer staples through discounted bulk sales, investors should have expected them to perform relatively well, or at least better than last year. This is because consumer staples have historically proven a safe place to invest during economic recessions. As households try to cut back on costs, they are apt to seize discounts on as much as they can, even if it means buying in bulk. Therefore, the lower profit almost seems counter intuitive to what should have happened. To be exact, they posted a net income of $239.7 million, or 55 cents per share. For the same quarter in 2008, they posted $327.9 million or 74 cents per share. This begs the question why did their profits fall, and additionally, does the company still make sense as an investment?
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First, their profits fell for a variety of reasons. The bulk retailer stated it was due to a decline in non-food sales, lower gas profits, lower international profits, increased discounts, and price reductions to attract more customers. They also said the recession led shoppers to cut back on bulk purchases. As a result, CFO Richard Galanti informed shareholders that the company would no longer post public forecasts for financial performance. All of this seems strange when compared to rivals in the same industry. By contrast, BJ's Wholesale Club (BJ: Charts, News, Offers), posted a higher profit than what Wall Street had expected. Wal-Mart (WMT: Charts, News, Offers), the parent company of Sam's Club, had also been doing well. They have beaten Wall Street estimates for the last six consecutive quarters.
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In analyzing the decline more thoroughly, lower profit margins from gasoline sales make sense (due to the declining price of oil) and the stronger dollar explains the lower international profit. Non-food sales may seem logical if you consider that consumers are being thriftier in their spending and the materials they use. However, bulk sales do not seem logical. Reports indicate that the average household size increased following the financial crisis, as individuals move in with family and friends to conserve on costs. If households are growing, bulk purchases logically should increase too. A more likely culprit for the Q2 results is what the accepted forms of payment. Cash and store credit cards aside, they prefer American Express (AXP: Charts, News, Offers) credit cards and Visa (V: Charts, News, Offers) or MasterCard (MA: Charts, News, Offers) debit cards in-store. Due to the financial crisis and the relatively frozen credit market, consumers are hard-pressed to qualify, let alone use their AmEx card. In addition, the target demographic does not carry generally one in their wallet. Taking it a step further, the number of people using AmEx is falling. Recently, some clients were encouraged to close their accounts. All factors considered, consumers that typically use other cards would go to rival discount stores to shop, regardless of costs.
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On the flip side, a 27 percent decline in profits is still a profit. Investors that do not know where to park their money may consider CostCo a decent investment. After all, they are the largest warehouse retailer in terms of sales and without clear signs of the recession easing up, this company may lend itself to a buy-and-hold strategy. This is the case because the stock has been relatively unaffected in early morning trading. Furthermore, share price is pretty close to 52-week lows which may indicate that the company is slightly undervalued in light of the recession. However, even though the company warned of a lower profit and analysts shifted their estimates downwards, the bulk-retailer still failed to meet the lower end of estimates. Investors should not forget this fact when they consider their alternatives.
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