Costco (COST) Posts a 13% Increase in Profit

Yesterday, wholesale superstore Costco (COST: Charts, News) topped Wall Street estimates with strong second quarter earnings and revenue. The company, based in Issaquah, Washington, posted earnings of 90 cents per share, or $394 million, on revenue of $22.97 billion. This was a 13% improvement in earnings and a 10% increase in revenue from the prior year's second quarter.

Analysts on average had expected earnings of 87 cents per share on revenue of $22.7 billion. The company attributed its strong results to the continuing success of its low-margin, high-volume wholesale approach, which attracts many customers in turbulent economic times. Earnings were also slightly boosted by a lower-than-expected tax rate during the second quarter. Costco offers a wide variety of groceries, household staples, clothes and electronics - making it a popular one-stop shop for consumers.

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The company also profited handsomely from its membership fees - which are required for entry to its superstores - which rose from $426 million to $459 million. Costco members can also shop online and purchase gas from their gas stations. Same store sales rose 8% in the United States and overseas during the quarter. In November 2011, the company increased its membership fees for the first time in five years, without any adverse effects.

Excluding distortions due to gasoline and foreign exchange volatility, same store sales actually grew an average of 7% across both markets. In addition to its 433 American stores, the company currently operates 82 stores in Canada, 32 in Mexico, 22 in the United Kingdom, 13 in Japan, eight in Taiwan, seven in Korea and three in Australia.

In January, Costco posted an 11% increase in sales to $7 billion. Domestic and international same-store sales increased 8% and 9%, respectively. In February, same store sales across the company increased 8%, outpacing the analysts' expectations of 7.6%.

Like its primary competitor Wal-Mart (WMT: Charts, News), Costco's gas stations, often combined with their superstores, flourish when oil prices rise. Costco offers gasoline at a discount to its superstore members, which in turn generates more membership fees. Despite these discounts, higher prices at the pump often decrease consumers' appetite for spending at Costco's superstores, making its gas stations a useful hedge against declining consumer sentiment. While gasoline sales drive revenue, the company makes far less in profits on each sale, due to the discount price.

Rising material costs have also become a challenge for Costco, which already uses paper thin margins to generate sales volume. Margins have declined for the past four quarters. In the second quarter, Costco's merchandise margins dropped 0.3 a percentage point to 10.53%, below expectations of 10.61%. Despite declining margins, Costco has been able to post sales increases between 11% and 17% over the past five quarters. Earnings per share have increased by double-digit percentages over the last eight quarters, signifying that margin erosion is still under control.

Costco investors should also be wary of the stock's comparatively high price. Shares of Costco have consistently flirted with 52-week highs, trading at 19.7 times forward earnings - a significant premium compared to Wal-Mart's forward multiple of 12.1. Shares are also currently above most analysts' price targets, which are hovering in the low $80s.

Costco's PEG ratio of 1.64 suggests that the stock can still grow at a healthy rate, as long as it keeps its revenue and earnings consistent. Costco also pays a 24 cent quarterly dividend, a 1.1% yield at current prices. Investors were relatively indifferent to Costco's earnings, and shares remained flat for most of the trading day yesterday.

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Costco 2Q Net Up 13% as Revenue Jumps
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Published on Mar 1, 2012
By Leo Sun
Leo Sun
Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

Copyrighted 2020. Content published with author's permission.

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