Despite weak quarterly numbers, Costco Wholesale (Nasdaq: COST) remains the premier operator of warehouse shopping, offering a limited selection of nationally-branded and private-label products at low prices.

The company currently has 510 warehouses with an average size of about 139,000 square feet, accommodating over 48 million club members. Costco has aggressively targeted traditional supermarkets and discounters. The scope and quality of its products and competitive low prices has made it the envy of the warehouse business. In addition to bulk groceries and consumer electronics, the company offers optical services, tires, photo processing, pharmacy and home remodeling items like cabinets and carpeting.

International Growth and the key to Domestic Success
Costco has grown steadily by opening new warehouses and driving sales higher in older locations. It has extended its reach to Canada (71 clubs) and Mexico (30) with several more in Japan, Korea and Taiwan. The discount warehouse plans to open 35 more clubs in 2007.

The average Costco store generates an impressive $127 million, an increase of over 25% since 2001. COST is one of the few retailers that can out-retail Wal-Mart, as they generate 50% more sales on average than Sam's Club stores.

Costco has higher-paid employees than Sam's Club (NYSE: WMT). Although this puts pressure on thin margins, its motivated workforce helps drive sales. Not only is COST winning the race among warehouse stores, it has put additional pressure on supermarkets.

Believe it or not, Costco shopping has now become chic and has changed the way many people shop across all income brackets. It has made one-stop shopping a must for busy folks, and the payoff has been consistently higher sales and earnings. The question in the future is can COST maintain the level of growth?

Financial Results
For the second-quarter results ending February 2007, sales and earnings were pretty much in line, but there were minor issues over foot traffic. Whereas in April, total net sales rose 12% as comp stores also rose 7%. Domestic comps rose 6% and international comps rose 10%, 8% in local currencies. Traffic counts, and average transaction amounts rose 3% and 4% respectively.

Third-quarter results increased 10% to $14.34 billion, and net income was $224 million, or 49 cents per share - essentially flat from a year ago. Comp sales in the United States were up 7%, international 10%. The consolidated comp store sales were up 7%. While the returns policy impacted the quarter results, management believes, overall, it will have a positive impact on future results. COST ended the quarter with over $3 billion in cash on its balance sheet. (To learn more, see Great Expectations: Forecasting Sales Growth.)

Bottom Line

Costco's challenge is to keep traffic high; thereby, pushing same store sales while keeping expenses under control. The return on capital is strong, but given the company's large size, it's hard to say if that's maintainable over the long term. There are still areas of growth, primarily overseas, which should enable COST to maintain it strong growth pattern. Domestically Costco may be able to steal additional market share from BJ's (NYSE: BJ) and other supermarkets. Long-term investors should do well.

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Tickers in this Article: COST, WMT, BJ

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