I recently upgraded to a video iPod from Apple (Nasdaq: AAPL ) . I don't actually have time to watch the darn thing, but it's simply cool to know that if I wanted to catch the latest episode of 24 during a lunch break, I'm armed with the technology.
Retailers love new toys to sell, but they can also be a headache, as Costco (Nasdaq: COST ) recently discovered. Seems a lot of other folks made the same upgrade, but returns of old iPods simultaneously went through the roof. Perhaps a few of those old units were broken, but the company suspects a lot of people were taking advantage of its liberal return policy ... definitely bad form. iPods are just one example of a problem that runs throughout the electronics arena.
Costco limited its return policy recently to 90 days on electronics -- still more liberal than Circuit City (NYSE: CC ) and Best Buy (NYSE: BBY ) . The company also took a $228 million hit to its reserve for return merchandise, which reduced third-quarter sales. The policy change is expected to have a favorable impact on future returns experience, but there will likely be some spillover from the old policy into the fourth quarter.
All this is to put Costco's third-quarter earnings release in context. Sales were up 10% but would have been 12% minus the returns reserve adjustment. EPS of $0.49 was flat with last year but, on an adjusted basis, was up 14% to $0.56.
Foolish investors should note two important numbers in the release. Comparable sales were up 7%, another outstanding quarter for the warehouse club leader and much stronger than the Sam's Club division of Wal-Mart (NYSE: WMT ) at 4% and BJ's (NYSE: BJ ) at 2%. It seems that none of the typical retail excuses (weather, economy) has an effect on Costco members filling up their shopping carts at an ever-increasing rate.
The second important number is membership income, which grew 15% during Q3. Unlike traditional retailers, this is the number I look at most closely for warehouse clubs. About 80% of Costco's operating income derives from the membership fee.
Most of what a warehouse club does is offer outstanding bargains to keep the cardholder base growing. Membership income is also an excellent leading indicator of sales -- more people ponying up for cards today means higher sales to come.
The stock can be somewhat volatile, particularly as Costco management doesn't coddle the analysts. I don't think it really cares what Wall Street thinks -- management is too busy trying to figure out the next super deal to offer its members. The company affirmed its full-year guidance during the call, for whatever that's worth. Returns for investors in Costco have lagged the market for the past year as the P/E multiple contracted. At 24 times trailing-12-month earnings, it's still higher than the market, but you pay for quality. I look to buy the stock on dips.
Costco and Best Buy are
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Motley Fool contributor Timothy M. Otte surveys the retail scene from Dallas. He welcomes comments on his articles, and owns shares of Wal-Mart and Costco, but none of the other companies mentioned in this article. The Fool has a disclosure policy.
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