Costco Carries Momentum in 2012

Costco Wholesale Corporation (COST - Analyst Report) has been making its way out successfully in an economy, still grappling with uneven recovery.

The U.S. economy has been reeling under the ongoing financial crisis, the rippling effects of which are gradually engulfing the global market. Amid this wobbly environment, Costco has almost been able to overcome the hurdles, keeping an upbeat note and sustaining momentum.

The company, which exited 2011 boldly by registering an average comparable-store sales growth of approximately 10.6%, is set to repeat the same performance in 2012 as evident from its comps data so far in the year.

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 remain on a positive growth track amid the beleaguered economic conditions, as cash-strapped customers continue to see it as a viable option for low-cost necessities.

Riding on Positive Comps

Costco is well positioned in the warehouse club industry, having delivered positive comps consistently so far in 2012.

From January to May, 2012, Costco has consistently registered comparable-store sales growth. In that period, comps growth touched a low of 4% and hit a high of 8%, thereby recording an average growth of approximately 6%. This is much better than its competitor Target Corporation (TGT - Analyst Report), which witnessed an average comparable-store increase of 4.8% in the same period.

In the first five months of 2012, comps increased 8% in both January and February, 6% in March, and 4% in both April and May.

Given the current macroeconomic environment, monthly sales data for Costco is also encouraging, with consistent growth. The company in the span of January to May 2012 registered minimum sales growth of 7% and a maximum growth of 11%, reflecting average growth of approximately 9% for the period. The company registered sales growth of 11% in January, 10% in both February and March, and 7% in both April and May.

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 open new clubs in domestic and international markets. The company’s diversification strategy is a natural hedge against risks that may arise in specific markets.

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 - 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.

Moreover, the company’s customers are sensitive to macroeconomic 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. Moreover, Costco holds a Zacks #3 Rank that translates into a short-term Hold rating.