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Will Costco Wholesale Defy the Weak Retail Environment?

By Dan Caplinger - May 20, 2016 at 1:57PM

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Many retailers have slumped this quarter, but investors hope the warehouse giant will overcome the pressure.

Image source: Costco Wholesale.

The business model that Costco Wholesale (COST 0.90%) has put together has resisted the onslaught of e-commerce specialists better than many other big-box retailers. Part of the reason is that the Costco experience encourages repeat shopping for bulk needs, and the up-front membership fee makes visiting the store something that its members value inherently. Yet the retail industry continues to evolve, and as Costco investors prepare for Wednesday's fiscal third-quarter financial report, they'll want to see if the warehouse giant can manage to buck the negative trends that many other retail companies have faced during the beginning of 2016. Let's take an early look at what people are expecting from Costco Wholesale and whether the company can reverse some negative sentiment recently.

Stats on Costco

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Data source: Yahoo! Finance.

Can Costco earnings climb back upward?

In recent months, investors have cut their views on Costco earnings, reducing their fiscal third-quarter estimates by a nickel per share and reducing full-year fiscal 2016 projections by three times that amount. The stock price has also fallen, declining 5% since mid-February.

Costco's fiscal second-quarter results created concerns for investors who had expected more from the retail giant. Total revenue was up 2.6%, but net income accelerated its pace of decline, falling 9%. Even after accounting for one-time items, adjusted earnings were down from year-ago levels and missed the consensus forecast among those following the stock. Membership fee income growth accelerated to nearly 4%, but an outsized rise in overhead expenses weighed on operating margin. Still, a decent amount of the downward pressure on Costco's results remains the huge deflation in gasoline prices on domestic results and the impact of the strong dollar on international performance. As those subside, Costco's fundamental strength should show through more. Yet Costco has already reported monthly results for two of the months in the quarter, and although they continued to indicate a slowdown, the same one-time factors were a big part of the sluggishness.

Still, concerns from other retailers have heightened the pressure on Costco. Several major department stores, for instance, have reported slowdowns in consumer spending in explaining shortfalls in revenue and earnings compared to what investors had expected them to report. Particularly vulnerable have been companies that sell products that are easily obtainable on the Internet through online retailers, and the increasing availability of free shipping and other incentives to use e-commerce rather than brick-and-mortar department stores could signal trouble for Costco as well.

Costco has admittedly been less exposed to the e-commerce trend, in part because part of the warehouse shopping experience involves the visceral appeal of seeing large amounts of a wide variety of different goods. Nevertheless, e-commerce specialists have done a good job of going beyond their initial focus areas to start delivering goods that were once seen as unlikely to support a move to an online format. Costco will need to keep building out its own e-commerce capabilities in order to fend off further competition.

One key aspect of Costco's performance that people will look forward to in the near future is the switchover in the Costco branded credit card from American Express to Visa. Cardholders are already getting their new cards during the quarter, and the website for the new Visa card says that customers can start using it on June 20, at which point the old AmEx card will no longer be valid. If customers are uncomfortable with the switch, then the transition might cause some further bumps in Costco's growth in the coming quarter.

In the Costco earnings report, watch for commentary on whether the warehouse retailer can avoid the same fate that some of its big-box counterparts in the retail industry have suffered over the past quarter. If Costco's competitive moat shows signs of breaching, then it could spell even more trouble for a stock that already hasn't given shareholders the kind of short-term returns that are consistent with its longer-term track record.

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Costco Wholesale Corporation
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