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Costco's Steady Start in 2012

Costco Wholesale Corporation (COST) continues to be a dominant retail wholesaler based on the breadth and quality of merchandises it offers. The company’s strategy to sell products at heavily discounted prices has helped it to remain on a positive growth track amid the beleaguered economic conditions as budget-conscious 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 and, as it enters 2012, it is carrying the same tempo seen last year.

Riding on Positive Comps

After an 8% increase in January 2012, Costco’s comparable-store sales for the month of February climbed by an equal percentage, reflecting comparable sales growth of 8% both at its U.S. locations and international divisions. This is marginally better than its competitor Target Corporation (TGT), which witnessed an average comparable-store sales increase of 7% in the same period.

Excluding the effects of higher gasoline prices and foreign exchange fluctuations, Costco’s comparable-store sales for February climbed 7%, with U.S. and international comparable sales increasing 7% and 9%, respectively.

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 opening 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 improved sales of discretionary items. Consequently, Costco witnessed double-digit growth in the top line during the second quarter of 2012, which subsequently led to an increase in the bottom line. The company’s international operations have been the major driver.

Costco’s second quarter earnings of 90 cents a share came ahead of the Zacks Consensus Estimate of 88 cents, and rose 13.9% from 79 cents earned in the prior-year quarter. In the first quarter of 2012, the company had posted 12.7% growth in the bottom line

After registering a growth of 12.4% in the first quarter, the warehouse retailer’s total revenue, which includes net sales and membership fee, climbed 10% year-over-year to $22,967 million during the second quarter that surpassed the Zacks Consensus Estimate of $22,737 million. Net sales jumped 10.1% to $22,508 million, whereas membership fee rose 7.7% to $459 million.

Costco’s comparable-store sales for the quarter rose 8%, reflecting a comparable sales increase of 8% both at its U.S. locations and international divisions. The results were favorably impacted by rising gasoline prices, but adversely affected by foreign exchange fluctuations.

Challenging Economy and Competition

The economy is still not out of the woods, and whether 2012 will mark a complete turnaround is difficult to predict unless some concrete steps are taken. Cuts are deep and wounds not completely 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 model that 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 macro-economic factors including interest rate hikes, increase in fuel and energy costs, a sluggish housing market, and high unemployment and household debt levels, which may affect their spending.

Closing Commentary

Based on the pulse of the economy, we believe that budget-constrained consumers will remain watchful of their spending and look for discounts. Consequently, we could see competitive pricing, compelling products and innovative ways to attract shoppers.

Given the pros and cons, we maintain our long-term “Neutral” recommendation on the stock. However, Costco holds a Zacks #2 Rank that translates into a short-term “Buy” rating.

Costco currently operates approximately 600 warehouses, including 433 in the United States and Puerto Rico, 82 in Canada, 32 in Mexico, 22 in the United Kingdom, 13 in Japan, 8 in Taiwan, 7 in Korea, and 3 in Australia.

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