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Taking Stock at Costco

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Even bulk sales are suffering.

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Costco (COST) appears to be well-positioned to gain market share and increase earnings when bargain-conscious shoppers again open their wallets for more than the bare essentials.

But there won't be any immediate miracles.

Analysts expect the company to earn $0.59 a share in the first quarter of 2010, down from $0.65 for the same period a year ago. The company is scheduled to report earnings Thursday.

People simply aren't buying. In the fourth quarter of 2009, Costco said net income fell to $374 million, or $0.85 a share, compared with $398 million, or $0.90 for the same period a year ago. Quarterly revenue fell to $22.4 billion from $23.1 billion.

"We expect Costco to increase market share as we see it pricing aggressively as it maintains a strong value position and a relatively upscale product mix that appeals to a more affluent consumer base," Standard & Poor's says in a research report. "…We think it is well positioned to generate future earnings growth due to new store expansion and what we view as a strong balance sheet."

Costco offers lower prices than many retail stores and this means the company must operate on thin margins. It succeeds by racking up huge sales and quickly turning over inventory. By some estimates, Costco sells its inventory about 50% faster than Walmart (WMT), the world's largest retailer. Analysts like this because the company quickly turns inventory into cash and generates strong returns on invested capital.

Costco also limits its inventory to about 4,000 items, including many in bulk packaging, compared with about 50,000 at other mass merchandisers. Costco does little advertising, depending instead on word-of-mouth. It works -- the company has about 56 million members in 40 states, Puerto Rico, Canada, Mexico, Japan, Taiwan, South Korea, and the United Kingdom. In November, the company operated 563 warehouses, including 410 in the US. Individual members, including spouse, pay a membership fee of $50 a year.

In fiscal year 2010, Standard & Poor's expects Costco to increase revenue by about 1.7% to $72.6 billion from $71.4 billion last year. Higher customer traffic is expected to offset smaller average purchases per person and falling prices in produce and electronics.

"We project that margins will widen, reflecting increased demand for discretionary goods and declining costs, despite rising employee health care costs and aggressive pricing to support traffic," Standard & Poor's says.

S&P expects earnings per share in fiscal year 2010 will increase about 15% to $2.90.

Standard & Poor's set a 12-month price target of $61 a share. In early afternoon trading Tuesday, the stock fetched $58.82, down $0.53, or 0.89%.

Competitors include Sam's Club, a division of Walmart and BJ's Wholesale Club (BJ).
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No positions in stocks mentioned.
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