Costco Caught in a Price Vice

by Alexandra Biesada, July 25th, 2008, 7:00 am

In my last post I noted that Costco Wholesale, the nation’s largest wholesale club (ahead of SAM’S CLUB), posted a healthy 5% same-store-sales gain in June, while less price-sensitive retailers showed weaker results. Now an update on Costco’s financial health reveals that the rise in sales came at the expense of profits as the company held the line on prices — even as its own costs rose — to please its members.

On Wednesday Costco warned that its fourth-quarter earnings (for the period ending Aug. 31) would come in well below analysts’ expectations. The warehouse club operator cited inflation, particularly high energy costs, as a root cause. Chief Financial Officer Richard Galanti noted in the announcement that Costco has been “holding selling price points to help drive sales and maintain the confidence of our members.”

Wall Street, not known for its loyalty, was quick to respond: Costco’s share price, up nearly 18% over the past year, fell almost 12% despite the company’s declaration of a quarterly cash dividend of $0.16 per share and an additional stock repurchase program of up to $1 billion. (That’s in addition to the $5.8 billion repurchase plan previously announced.)

Clearly, Costco is struggling to balance the interests of its shareholders with those of its members. So far, it appears to be favoring members. Loyal Costco shoppers, who are more affluent than members of rivals SAM’S Club and BJ’s Wholesale Club, have rewarded the retailer by renewing their memberships and buying more of its merchandise. Galanti noted that Costco’s sales continue to be strong relative to other retailers.

Wall Street, which in the past has knocked the company for lavishly rewarding employees with generous salaries and benefits at the expense of its bottom line, apparently feels that investors are getting short changed again.

Still as food, fuel, and other commodity prices continue to rise, Costco will eventually reach the point where it’s forced to blink and raise prices. In the meantime, Costco appears willing to see margins suffer in order to defend, and perhaps win, market share.