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Costco Connecting with Consumers

Since initiating a position in Costco (COST) with a LO in August I’ve been both surprised and pleased with the performance of the common shares as I’ve watched them rise over 30% in the face of both good and bad news of weak consumer data and the relative performance of other retail stocks.
Costco released their Q4 and full year 2009 results today and I’ve been busy updating my spreadsheet to get a sense of what the landscape for Costco might look like come the release of their full year report in December.

The numbers were good by analyst estimates with Costco’s net sales down 3% to $21.9B as of August 31st, 2009. Net income for the fourth quarter was down $0.05/share or 6% YoY. These numbers, while down, illustrate the ability of management to minimize sales erosion during a recession and keep consumers in their warehouses buying products and using services.

I’ve tried for most of the morning to get some early numbers from the company on their gross margins so I can quickly compare their 2009 results with previous years. If readers remember my post on Costco from last year (Taking Stock in COST) there was a large portion dedicated to explaining the importance of how Costco doesn’t compete on price by staying committed to maintaining their margins.

Historically gross margins (as a % of sales) have averaged 10.28% with management improving this metric over the last five years to an average of 10.60%. When you compare these numbers to other retailers Costco has a clear advantage and one it protects very well with the type of business it operates (membership).

I did find in the numbers today that SGAE (selling, general and administration expenses) as a % of sales has climbed to 10.38% vs. a historical average of 9.56%. Hopefully this reflects an improved effort to reduce sales erosion by management rather than going lack on their long-term commitment to stay in control of costs. SGAE had been holding steady at an average of 9.80% over the past five years so an increase to nearly 10.4% does seem high despite the increased challenges a recessionary environment presents.

I was glad to see that Costco has increased their number of warehouses by nearly 9.4% to a total of 560 warehouses. This is well above their average yearly commitment of a 6% increase and will help to improve future earnings of the company by providing a larger retail footprint domestically and globally.  Companies with strong balance sheets and high margins have both the cashflow and financial resources to expand operations in a recession in anticipation of better performance when the economy recovers.

The market in turn seems to be rewarding the company (and shareholders) for their consistent and effective operations in this economic environment where consumer spending has fallen and unemployment remains high.  I know that with the purchase of my first home I’ve been an even more regular Costco shopper for all assortment of household needs, groceries and supplies.

Disclosure: I own shares in Costco (COST)

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{ 3 comments… add one }
  • Anonymous October 7, 2009, 12:37 pm

    Maybe i should think about buying some shares then in Costco? Interesting srticle thanks

  • Sampson October 15, 2009, 10:20 am

    Great post. I've always believed Costco to have a wonderful business model and the strength in its ability to grow earnings at a high and consitent pace lends to this fact.

    However, as a stock I've been hesitant, as the market seems to bequite steadily reducing what its willing to pay. Costco seems to have changed from a high growth stock (warranting P/E's in the 40's in the early 2000s to a normal growth stock with a P/E in the low 20s). It'd have to trade in and around $50 again for me to be interested – but that's when you got it 😉

  • Nurseb911 October 15, 2009, 2:11 pm

    Good point Sampson. I watched COST for a long time as both a consumer and investor. I finally felt that an initial position at just under $50 seemed prudent. I'm happy with management, the company continues to offer members products/services they want and the fact the market isn't willing to pay for higher growth is fine with me when I can see in my own analysis of their numbers that they're growing at a very nice pace.

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