Costco Blends Low Costs With High Profits

By Wayne Pinsent | May 29, 2008 AAA

As consumers clutch their wallets a little tighter, companies who can deliver the goods at cheaper prices have soared. On Thursday, discount club Costco Wholesale (Nasdaq:COST) reported better-than-expected profits, as price-conscious consumer flocked to the company's stores in response to rising food and energy prices.

Great Top and Bottom Line
For its fiscal third quarter Costco's net income jumped 32% to $295.1 million (67 cents per share) from $224 million (49 cents per share) from one year earlier. The year ago numbers were brought down a bit by Costco taking on additional reserves to cushion for customer returns. The profits came 2 cents ahead of analyst expectations, and helped display some of the core strength in the Costco brand, especially in the current economic environment.

The report on the top line looked good as well. Net sales, excluding membership fees, rose 13% to $16.62 billion from $14.34 billion in the year ago period. Membership fees rose 10% to $350.9 million from $317.7 million. Both numbers are impressive, and indicate that the company is growing sales currently with its existing customers as well as adding to that base. (To learn how to interpret earnings, read Understanding The Income Statement.)

Discount Retailers Shining Bright
In general, the retail environment is not great. Sears (NYSE:SHLD) swung to a loss and reported dismal sales numbers as the company's Sears and K-mart stores flounder. Still the discount clubs have been doing fantastically as consumers look for deals on staple products. BJ's Wholesale Club (NYSE:BJ) and Wal-Mart (NYSE:WMT), which owns discount chain Sam's Club, have seen great results as well. And even though Wal-Mart's namesake stores are benefiting, the biggest gains for the company have been at Sam's Club.

The discount clubs have been a bright spot in the retail sector, and I think they will continue to perform. The best indication is that memberships have been increasing at a nice pace. A lot of people who may have shunned these clubs in the past are now finding the cost-benefit to be very attractive. The benefit has always been there, but the economic worries that have sprung up have caused consumers to take a closer look. Of the three discount clubs, Costco is the costliest with a trailing price to earnings multiple of 27. BJ's Wholesale is around 20, and Wal-Mart is at 18. Costco's growth can justify the premium, but I think all three are going to perform well. (For more on the Price to earnings ratio, check out Understanding The P/E Ratio.)

The Bottom Line
Costco has shown that the discount clubs are one of the nice areas in a bad sector. The company reported great results that exceeded expectations. I think the company, as well as its peers, will continue to do well as consumers become more cost conscious. The growth in memberships is also a great sign for the company's future, and I like the stock.

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