Ringing Up Bulk Sales

Despite hitting a bump in the road in August, Costco is on track to record another stellar year as it continues to lead the way among warehouse retailers and put more distance between itself and main rival Sam’s Club.

While Costco isn’t scheduled to report its fiscal 2007 earnings until Oct.11, preliminary reports show Costco’s sales increased 7% to $63.06 billion for the year ended Sept. 2, giving it a solid hold on the No. 2 spot among general merchandise retailers in the United States. As usual, sales were driven by food, electronics and pharmacy, three categories that have been outperforming other areas for the past several years.

Food sales—led by meat and produce—continued to post double-digit gains. Costco’s biggest move in food this year was a deal it signed with Martha Stewart Living Omnimedia and it is scheduled to launch a co-branded Martha Stewart line of fresh, refrigerated and frozen foods by the end of 2007. Pharmacy is another high growth area for Costco and it generated $2.57 billion in sales in fiscal 2007, ranking it among the top 10 pharmacy retailers in the country. The chain wrote 26.3 million prescriptions in 2006 and expects that number to top 30 million in 2007. It also launched a program in January providing customers with 100-count supplies of 200 different generic drugs for $10, an alternative to the $4 programs for 30-count supplies at other chains.

In consumer electronics, Costco is on its way to bettering the $1.8 billion in TV sales it generated in fiscal 2007 and is complementing flat-panel TV sales with a move into high-definition DVD. It began carrying both HD-DVD and Blu-ray DVD players in stores this summer along with DVDs in both formats.

And it’s been another year of rapid growth. Costco added 30 new stores during the year and finished with 518 overall. Costco director of investor relations Bob Nelson said its goal is to open 30 to 35 new stores in fiscal 2007, with up to 15 of those stores slated to open between now and the end of December.

While Costco established another record year in sales that topped $63 billion, it may not equal its record earnings of $1.1 billion recorded in 2006. For the first nine months of the fiscal year, Costco generated $710.4 million in earnings compared to $746 million during the same period last year. But those earnings would have topped $793 million if not for two one-time charges.

In May, Costco transferred $30.3 million to its sales returns reserve fund to cover expenses related to rampant returns on high-priced consumer electronics items, a problem it addressed in March when it adopted a new, 90-day return policy (see sidebar, page 10). Costco also took a $46.4 million charge to offset tax consequences related to inconsistencies an internal review uncovered in past stock option grants.

But despite those charges, Costco could still improve on its record earnings from last year. “We can’t talk about it until our Oct. 11 call, but we’re on track for our fourth-quarter earnings and should do pretty well for the year,” said Nelson.

Costco continued to generate solid gains in same-store sales for the year with a 6% increase and was able to do it despite a slow month of August when same-store sales increased only 2%, with sales at U.S. stores jumping just 1%. Costco cited poor weather in California as a primary source for the slump (California is home to 29% of its stores base).

“Extreme high temperatures in California during the month of August impacted customer traffic negatively, but we’re hopeful that we’ll bounce back,” said Nelson during a Sept. 5 conference call on August sales. The record heat contributed to a 4.5% decline in customer traffic in stores in California for the month.

Costco continues to thrive outside of the United States and now operates 135 international stores, with more than half of those north of the border in Canada (71), plus 30 in Mexico. It also operates 19 stores in the United Kingdom, five in Korea, four in Taiwan and six in Japan, where it opened its newest store in Kawasaki on July 12. Costco reported a 9% increase in same-store sales for the year at its international stores compared to 5% in the United States. The company opened its first urban store in Canada in downtown Vancouver last November.

Costco hasn’t opened a store in a new country in more than seven years and isn’t likely to do so in the near future. Ceo Jim Sinegal said the chain is exploring opportunities in China, but said any venture there is at least five years off. One territory Costco may enter soon is Australia, a country with little competition and a customer base it is more familiar with. Costco acknowledges that it is exploring opportunities in Australia, but has no immediate plans to expand there.

Costco has also stepped up its sustainability efforts this year by installing solar power systems at two stores in California that the chain estimates will pay for themselves in two years. It also announced plans in September to install solar panels at four stores in Hawaii by the end of 2007. Costco has also implemented special parking spaces for hybrid vehicles at some stores equipped with chargers for customers to juice up their batteries while they shop.

As for ancillary businesses, Costco’s photo centers continue to thrive, and they should easily exceed the 1 billion prints they processed in 2006. And the company expects sales at Costco.com to top $1 billion this year after producing $880 million in sales in fiscal 2006.

The company is still trying to determine whether to expand Costco Home, its home furnishings venture that currently has stores in Arizona and Washington. It has been considering a third opening in the Pacific Northwest for some time, but hasn’t announced any definite plans.