Costco Says Both Costs and Comps Rose

Updated from 12:57 p.m. EDT

In reporting its third-quarter earnings on Wednesday, Costco ( COST) gave bulls and bears both something to chew on.

The wholesale club chain reported strong earnings growth in the quarter,boosted by strong comparable-store sales. But the company also reportedcontinuing trouble with its operating expenses and announced that its totalstore openings this fiscal year would come in below its previousprojections.

Although the company is performing well compared to its competition, itcould be doing a lot better, said one hedge-fund manager, who asked not tobe named.

"They've done a great job for their employees. They've done a great jobfor their customers. But they've done a mediocre job for shareholders," saidthe fund manager, who does not have a position in Costco.

Despite this sentiment, the bulls were winning the day in afternoontrading, as Costco's stock was up 97 cents, or 2.7%, to $36.89.

In its quarter ended May 11, Costco earned $153.8 million, or 33 cents ashare. On a per-share basis, the company's earnings were up 18% from theyear-ago period.

Meanwhile, the company's sales, excluding membership fees, increased 11%in the quarter to $9.34 billion. On a same-store basis, which compares similar outlets open more than one year, Costco's sales grew 6% over the year-ago period.

Blaming the weather and the war in Iraq, many other large retailersposted weak comparable-store sales in their just-completed quarters.Costco's performance outpaced its two chief rivals, Wal-Mart's ( WMT) Sam's Cluband BJ's Wholesale Club, which posted comparable-store sales gains of 2.2%and 5.7%, respectively, in their just-completed quarters.

"(Costco's) comps were outstanding," said another fund manager, who alsoasked not to be named and who holds no position in the company. "Six percent in this environment, that's reallyterrific."

Much of Costco's bottom-line lift came from gasoline sales. As gasolineprices fell in the quarter, the company was able to retain some of itsprofit margin, dropping prices to customers slower than its costs werefalling.

But company officials acknowledged that the spike Costco saw in itsprofit margin from gasoline was an "anomaly," that may not recur.

"They made a lot of money on gasoline this quarter," said the first fundmanager. "But that's not a controllable thing."

Where the company should have some control is over its operatingexpenses. But those costs continue to go up. In the company's secondquarter, Costco missed analysts' earnings estimates, which it attributed torising health and workers' compensation costs.

Although the company topped its own and analysts projections in itsthird quarter, operating expenses continued to weigh on its results. In thequarter, operating expenses increased 32 basis points as a portion of sales,largely as a result of increased health care expenses.

Company officials said they are looking into the issue and areconsidering making changes to employees' health plans to rein in costs.

But the continued increase is a source of frustration for investors andanalysts.

"The frustration is that this is the one thing they can control, andthey haven't done anything about it yet," said the first fund manager. "Ithink they're living in Wally World with how they're treating theiremployees."

Where the company has cut back is with store openings. Costco originallyplanned to open 30 to 32 new stores this fiscal year. But last quarter,company officials told analysts that it had cut back on those projections,planning to open just 25 to 26. Now, the company may open only 24 this year,company officials said.

Those cutbacks have brought down capital expenditures and pre-openingcosts. But they also mean that the company may not be able to grow itsrevenue as quickly in the future as it has been.

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