Why Costco Isn’t Getting Crushed by Wall Street

The Fiscal Times

Costco Wholesale Corp. today reported worse-than-expected quarterly earnings — the fourth time in a row that the discounting giant’s profits have disappointed Wall Street. 

“I am as shocked as you are,” said Brian Yarbrough, an analyst with Edward Jones who rates Costco as a “hold.” 

For most companies, a streak like that would crush their stock price, but investors are willing to cut Costco some slack given that its earnings, even as they fell shy of analysts’ expectations, rose 3.1 percent and quarterly sales topped expectations. 

More importantly to the long-term picture, its unique business model and comparable sales growth that is among the best in retail. Costco’s shares traded up slightly Thursday, and are down about 4 percent on the year.

That slide has been slight enough for The Wall Street Journal to declare that “Costco Doesn’t Look Cheap Enough,” especially given the competitive challenges it still faces.

Retailers of all stripes have posted weak earnings for the beginning of 2014, and Costco was clearly affected by the same wintry economic headwinds that hurt chains such as Wal-Mart (NYSE: WMT), Target (NYSE: TGT) and TJX (NYSE: TJX), the parent of TJ Maxx.

“The weather turned out to be worse than many of us had anticipated,” Yarbrough said, adding that it hurt some chains far more than others. Wal-Mart is a case in point. As Yarbrough noted, “they haven’t been lighting the world on fire” even when the weather wasn’t a factor.

Unlike those competitors, though, Costco has managed to grow its sales at stores open at least a year, a key retail metric. Same-store sales at Costco rose 6 percent when the impact of gasoline and foreign exchange is excluded. Wal-Mart’s Sam’s Club, by contrast, saw a decline in same-store sales over the same time period.

Related: The 14 Best Supermarkets in America in 2014

During the most recent quarter, net income at Costco fell to $473 million, or $1.07 per share, versus $459 million, or $1.04 per share, last year. Revenue rose 7 percent to $25.8 billion. Wall Street analysts had expected profit of $1.09 per share on sales of $25.73 billion. 

Also unlike most retailers, Costco generates a sizable share of its operating income from charging membership fees to shop at its cavernous stores rather than on the sale of goods and services. In the latest quarter, it earned $561 million in sales from membership fees, up 6 percent from $531 million in the year-earlier period. 

That indicates that consumer interest in the stores remains strong even as Costco’s costs continue to rise. And those members keep paying even if they cut back on shopping. 

Low prices are an obvious draw for customers and the company has been slashing them further to boost traffic. In fact, many people find the deals at Costco for products such as fresh food and generic drugs too good pass up compared with other chains, even when factoring the bulk sizes that Costco sells. 

Executing this strategy isn’t easy since it requires the chain to absorb increased costs and not pass them onto the consumers. Its operating margins are about 2.9 percent, about half the 5.6 percent earned by Wal-Mart and Target’s 5.5 percent.

The payoff for Costco, however, can be huge.

“They cater to a more affluent customer,” said Joe Feldman, an analyst with Telsey Group, in an interview before earnings were released. “A lot of them are homeowners.” 

Costco is unique in other ways as well. While rivals such as Wal-Mart have bitterly fought efforts by unions to organize their workforce, Costco welcomes them. In fact, CEO Craig Jelenik has come out in favor of raising the minimum wage and his company pays well above that level. Those types of policies help explain why Costco ranked second in the rankings released recently by Glassdoor of the best employers for compensation and benefits. Jelenik also doesn’t see the need to have a public relations staff, a rarity in the tight-lipped world of corporate America. 

Related: 10 Best Companies for Pay and Benefits in 2014 

Another Costco quirk is that it doesn’t hire business school graduates because, as Bloomberg Businessweek noted last year, the company wants to “preserve its distinct company culture.” It must be working because employees rarely leave.  The magazine said turnover runs at about 5 percent. 

Even with its unique corporate culture, Costco isn’t immune from the machinations of the larger economy. Shoppers aren’t going to feel like going to buy warm weather clothes such as shorts and t-shirts if the temperatures outside are freezing — and many retailers cut earnings guidance because consumers continue to keep a close eye on their wallets. 

Whether warmer weather and a rebounding economy will be enough to enable Costco to break its “losing streak” is hard to say. Investors, though, are betting on it. 

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