Costco May Have Outgrown the Club Scene

Costco may be running out of steam.

That's the word from a number of analysts following the company's earnings report this past week. Although the wholesale club chain met lowered expectations by posting earnings of 31 cents per share, Costco cut its outlook for its fiscal second quarter and the rest of its 2003 fiscal year.

Costco's disappointing outlook comes on top of slowing revenue growth, increased expenses and intense competition. Add it all up and Costco in specific and the wholesale club market in general seem to be running up against the law of diminishing returns.

"Like many, we view Costco as the finest of the wholesale club operators. However, we continue to believe the company's niche is fast approaching saturation," wrote Wayne Hood of Prudential Financial in a research report on Tuesday. (Prudential does not have any investment banking business with Costco.)

Following a wave of reports such as Prudential's, Costco shares traded down $1.04, or 3.5%, to $28.52 on Friday.

Costco has been one of the bright lights in the dismal retail sector over the past few years, posting strong revenue and earnings growth. The chief question it faced until recently was its valuation; as recently as May, the company was trading at 23 times next year's earnings, a considerable premium to its then projected growth rate of 15%.

But the company has faced increased scrutiny since September, when it lowered its earnings guidance for its just-ended quarter. Disappointing same-store sales growth in October and November has amplified those concerns.

On Thursday Costco posted earnings of $145.7 million, or 31 cents per share, on $9 billion in revenue for its fiscal first quarter, which ended November 24. That was up from $129.7 million, or 28 cents per share, on $8.3 billion in revenue in the same period last year.

Costco met its earnings guidance, which it had revised downward last month. Continuing the trend, the company lowered expectations for its second fiscal quarter, saying it expected earnings of 42 to 44 cents per share, compared with the 46 cents that Wall Street analysts were expecting.