Updated from 12:57 p.m. EDTIn 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 reported continuing trouble with its operating expenses and announced that its total store openings this fiscal year would come in below its previous projections. Although the company is performing well compared to its competition, it could be doing a lot better, said one hedge-fund manager, who asked not to be named. "They've done a great job for their employees. They've done a great job for their customers. But they've done a mediocre job for shareholders," said the fund manager, who does not have a position in Costco. Despite this sentiment, the bulls were winning the day in afternoon trading, 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 a share. On a per-share basis, the company's earnings were up 18% from the year-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 retailers posted weak comparable-store sales in their just-completed quarters. Costco's performance outpaced its two chief rivals, Wal-Mart's ( WMT) Sam's Club and 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 also asked not to be named and who holds no position in the company. "Six percent in this environment, that's really terrific." Much of Costco's bottom-line lift came from gasoline sales. As gasoline prices fell in the quarter, the company was able to retain some of its profit margin, dropping prices to customers slower than its costs were falling.
But company officials acknowledged that the spike Costco saw in its profit margin from gasoline was an "anomaly," that may not recur. "They made a lot of money on gasoline this quarter," said the first fund manager. "But that's not a controllable thing." Where the company should have some control is over its operating expenses. But those costs continue to go up. In the company's second quarter, Costco missed analysts' earnings estimates, which it attributed to rising health and workers' compensation costs. Although the company topped its own and analysts projections in its third quarter, operating expenses continued to weigh on its results. In the quarter, 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 are considering making changes to employees' health plans to rein in costs. But the continued increase is a source of frustration for investors and analysts. "The frustration is that this is the one thing they can control, and they haven't done anything about it yet," said the first fund manager. "I think they're living in Wally World with how they're treating their employees." Where the company has cut back is with store openings. Costco originally planned 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-opening costs. But they also mean that the company may not be able to grow its revenue as quickly in the future as it has been.