Updated from 6:48 a.m. EDT
Investors received yet another sign of slowing in the retail sector Wednesday, with
warning that its fourth-quarter earnings would come in below expectations.
The discount warehouse club retailer said its August same-store sales, or sales at stores open for at least a year, held up in August with a 5% increase, while total sales rose 11% to $4.55 billion. Profit margins, however, were hurt by markdowns in recent months.
Costco now expects to earn between 68 cents and 71 cents a share for its fourth quarter, which ends Sept. 3. Excluding a charge related to foreign income tax assessment reserves, the company projects earnings of 71 cents to 74 cents a share, which still misses analysts' average estimate of 77 cents a share, as reported by Thomson First Call.
"With respect to competition, it's as tough as ever, but it's not really the true culprit here," said Costco CEO Jim Sinegal on a conference call with analysts. He said the reduced outlook resulted mainly from markdowns in big-ticket items like electronics and furniture. He also said there are slightly higher markdowns taking place in apparel compared with the same quarter last year.
Sinegal said the markdowns in big-ticket items is "consistent with what we're seeing in the big-ticket economy, if you will." He said the first month in the quarter exceeded profit expectations, but subsequent months got progressively worse with respect to margins.
Sinegal said he remains "cautiously optimistic" on Costco's prospects for 2007, but he is concerned about the slowing housing market and other economic factors that appear to be crimping consumer spending in the second half of 2006.
The entire retail sector has been under pressure throughout the summer as a softening residential real estate market combined with high fuel prices and rising interest rates to bring long-held concerns about consumer spending in the market to the foreground. On Tuesday, the Conference Board reported that its consumer confidence index dropped in August to its lowest level since the aftermath of Hurricane Katrina.
"This is more a function of a slowing economy and consumer spending than it is a comment on Costco's business model or its ability to execute," says Robert Toomey, analyst with E.K. Riley Advisors. "We're in a slower retail period that will continue for at least a couple of quarters, but the offset will be continued moderate economic growth and employment growth, which will keep overall retail spending afloat."
Toomey says he sees little opportunity for margin improvement at Costco in the near term, but he said the stock could be getting cheap for a long-term buyer. He holds a buy rating on the stock.
In a research note, Credit Suisse First Boston analyst Michael Exstein wrote that Costco is still among the "premier business models in retail" with longer-term opportunities for margin expansion.
"However, earnings are likely to remain under pressure in the near-term as gas prices remain at elevated levels and consumer sentiment moderates," he said.
Shares of Costco recently were down $2.38, or 4.8%, to $46.87.