Earnings Preview: Costco

Costco Wholesale Corporation ( COST - Analyst Report ) , one of the leading U.S. warehouse club operators, is slated to report its third-quarter 2012 financial results on Thursday, May 24.

The current Zacks Consensus Estimate for the quarter is 87 cents a share that reflects a growth of 8.8% from the prior-year quarter’s earnings. The estimates in the current Zacks Consensus range between a low of 81 cents and a high of 90 cents a share. The Zacks Consensus revenue estimate is pegged at $22,737 million for the quarter under discussion.

Recap of Second-Quarter 2012

Costco’s second-quarter 2012 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.

The increase in the bottom line was buoyed by double-digit growth in the top line on the back of improved sales of discretionary items, asconsumers seeking discounts started flocking to warehouse clubs.The company’s international operations have been the major driver.

The warehouse retailer’stotal revenue, which includes net sales and membership fee, climbed 10% to $22,967 million from the prior-year quarter, and 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.

Zacks Agreement & Magnitude

The Zacks Consensus Estimate for the third quarter hasn’t shown any movement in the last 30 days, as the upward and downward revisions made by analysts neutralized the impact. Of the 22 analysts following the stock, one analyst revised the estimate upward and another analyst lowered the same in the last 30 days. In the last 7 days too, the Zacks Consensus Estimate remained constant, since an upward revision in the estimate made by 1 analyst did not have a substantial impact. None of the analysts trimmed their estimates in the last 7 days.

Mixed Earnings Surprise History

With respect to earnings surprises, Costcohas missed, met as well as topped the Zacks Consensus Estimate over the last four quarters in the range of negative 0.9% to positive 2.3%. The average remained at positive 0.7%. This suggests that Costco has outperformed the Zacks Consensus Estimate by an average of 0.7% in the previous four quarters.

In the second quarter of fiscal 2012, the earnings beat the Zacks Consensus Estimate by 2.3%, whereas in the first quarter it met the Estimate. In the fourth quarter of 2011, the earnings missed the Estimate by 0.9%, however, in the third quarter it came in line with the same.

Closing Comment

Costco continues to be a dominant retail wholesaler based on the breadth and quality of merchandise it offers. The company’s strategy to sell products at heavily discounted prices has helped it to sustain growth in beleaguered economic conditions as cash-strapped customers continue to reckon Costco as a viable option for low-cost necessities. Having delivered consistent comparable-store sales growth, Costco is strongly positioned in the warehouse club industry.

However, Costco faces stiff competition from Target Corporation ( TGT - Analyst Report ) and Sam’s Club, a division of Wal-Mart Stores Inc. ( WMT - Analyst Report ) , 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.

Based on the pulse of the economy, we believe that budget-constrained consumers will remain watchful on 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. Moreover, Costco holds a Zacks #3 Rank that translates into a short-term “Hold” rating, and correlates with our long-term view.