Costco Is "Nervous" About Inflation As Profit Rises 6%

Wall Street Journal
By Karen Talley
Costco Wholesale Corp. is still seeing strong demand for its merchandise, but is dealing with broad inflation for products ranging from dog food to plastic cups.

The impacts showed up in the wholesale club's fiscal third-quarter earnings and may be a precursor to what other retailers, such as mass merchants and supermarkets, will face because they may not have placed significant orders yet at the newly elevated prices. Costco sells its inventory very quickly and, as a result, is already restocking merchandise at the higher prices.

"We saw quite a bit of inflationary pricing," during the third quarter, and the pressure is expected to continue in the current period, Chief Financial Officer Richard Galanti said during a conference call with analysts.

"Everything from dry dog food up 3.5%, to all your detergents of 10% plus, to various waters 10% or so, to all your plastic, your plates and your plastic cups and everything, 8% to 9%," Mr. Galanti said. "We're fighting to keep them lower, keep them delayed."

Costco has to walk a fine line between absorbing the costs and passing them to customers because of its positioning as a warehouse club that, while catering to generally higher-end consumers, does have a reputation for offering decent prices. The company's strategy is to "hold prices as long as we can" at levels customers are used to, but at least some increases will likely be passed along, Mr. Galanti said.

The company won't, however, begin offering cheaper merchandise because of how customers can react, Mr. Galanti said. "When you trade yourself down, it's darn tough to get them back."

Still, Costco's fundamental business continues doing well, with all categories except electronics showing growth during the quarter. Customers remain focused on food, sundries and gasoline, similar to what other mass merchants pointed to during their own quarterly reports.

Costco's third-quarter earnings rose 6% as strong same-store sales growth and expense controls more than offset a slight decline in margins.

The largest U.S. warehouse-style retailer by revenue also benefited from stronger foreign currencies in addition to a bulk selling approach that appeals to cost-conscious consumers.

For the quarter ended May 8, Costco reported a profit of $324 million, or 73 cents a share, up from $306 million, or 68 cents a share, a year earlier. The most-recent quarter included a pretax $49 million, or seven-cent-a-share, last-in-first-out charge. Last-in-first-out, or LIFO, is an accounting approach that requires revaluing inventory if prices are rising or falling. Since prices are rising, Costco had to value the inventory higher, which resulted in the a LIFO charge.

Revenue jumped 16% to $20.62 billion.

Analysts polled by Thomson Reuters had forecast earnings of 77 cents on revenue of $20.14 billion.

Same-store sales, excluding currency changes and gasoline, were up 7%. The sales increased 6% in the U.S. and 11% internationally. Total same-store sales, including Mexico stores, rose 12%.

Operating margin slipped to 2.7% from 2.8%. Membership fees, which typically make up the majority of the company's operating profit, rose a strong 10% to $435 million from $395 million a year ago.

Costco's inventory at the end of the quarter was up 15.3% compared with a net sales increase of 16.1%. Retailers have been trying to keep inventory in line with sales as a way of matching supply with demand.

Costco operates 581 warehouses, 425 of which are in the U.S.

March US Retail Sales Showing Unexpected Strength

Dow Jones Newswires
By Karen Talley

U.S. consumers spent March on the move, allowing many retailers to deliver solid sales numbers that suggest resilience in the face of challenges from a later Easter, poor weather and higher gasoline prices.

Early reports from companies including warehouse club Costco Wholesale Corp., Victoria's Secret operator Limited Brands Inc., and teen retailer Zumiez Inc. show considerably better gains than expected at stores open a year or more.

Others, including Hot Topic Inc., Stage Stores Inc. and apparel retailer Cato Corp. posted drops in same-store sales from a year earlier, but the declines were less than analysts projected.

"I wouldn't necessarily say the performances we're seeing for March was remarkable, because expectations were so low," said John Long, retail strategist at Kurt Salmon. "It will take April and the Easter holiday to really gauge what's going on, especially on the apparel side."

Wet Seal Inc., a young women's retailer, reported a 4.7% gain in same-store sales compared with expectations for a 1.7% drop. Chief Executive Susan McGalla said the company estimated same-store sales would have increased at a high single-digit percentage without the effect of a later Easter, but that April would benefit as a result.

The month did see robust growth in employment, with non-farm payrolls showing the addition of 216,000 positions, spurring hopes for a sustained employment recovery. The stock market also continues rising, a plus especially for higher-end shoppers.

Costco, which posted a 13% rise in same-store sales when analysts were projecting a 7.4% gain, continued to benefit from higher gasoline prices at the pumps at its clubs, favorable foreign exchange rates and the continued economic recovery in California, where the company has a significant presence.

Costco's international operations showed continued growth, with foreign sales rising 17% for the month, while U.S. sales increased 11%. Costco said its Tamasakai, Japan, warehouse, closed for repairs from earthquake damage, is expected to reopen before the end of the year.

While many other big players are still to be heard from, including Target Corp., Macy's Inc. and Saks Inc., it is looking like retailers will beat expectations as a group.

The 25 retailers tracked by Thomson Reuters are expected to post a 0.7% drop in same-store sales for last month, with much of the reservations for a stronger showing the result of Easter being its latest since 1943. The calendar shift pushed buying into April. The March showing is expected to be followed by 7.5% gain in April. As a result of the April momentum, sales for the two months are expected to show 3.4% growth, which Thomson Reuters considers healthy buying.

Easter fell on April 4 last year and is three weeks later this year on April 24.

And consumers are expected to buy. U.S. retail spending on Easter related merchandise, for everything from cookware to clothing, is expected to average $131.04 a person this year, up 11% from a year ago, the National Retail Federation said. The figure is based on a poll of consumers. The increase suggests momentum and is "a good sign leading into the much busier and important months to come," said Matthew Shay, the trade group's president.

Retailers in coming months will look to back-to-school and Christmas holiday buying to the lion's share of their annual sales. They are also facing increasing cost pressures from rising cotton and labor prices and will have to see what kind of price increases shoppers will absorb.

Target Takes The ‘No Dirty Gold' Pledge For Jewelry Sales

Only two of the top 10 U.S. jewelry retailers-Macy's and Costco-have not signed the No Dirty Gold campaign pledge to seek jewelry comprised of responsibly mined gold and other precious metals.

MineWeb
By Dorothy Kosich

Target, the third largest U.S. retail chain and the 10th ranked domestic jewelry retailer, has become the 73rd signer of EARTHWORKS' No Dirty Gold campaign pledge to seek cleaner sources of gold and other precious metals for jewelry.

The Washington, D.C.-based NGO EARTHWORKS said Target now joins luxury brands, such as Tiffany and Cartier, to retail chains like Sears/Kmart, Walmart, QVC and JC Penney, who have agreed to buy precious metals only from mining companies, which abide by "The Golden Rules."

Macy's and Costo are the two remaining retailers in the "Top 10" who have not signed the pledge.

EARTHWORKS says the Golden Rules pledge has now been signed by eight of the top 10 jewelry retailers in the country, with combined total annual sales of more than $13.5 billion, or about 25% of the total U.S. jewelry market.

These rules call on mining companies to respect basic human rights; obtain the free, prior and informed consent of affected communities; ensure mining operators are not located in areas of armed or militarized conflict; and ensure that mining projects do not force communities off their lands.

Other golden rules call for mining projects that are not located in protected areas, fragile ecosystems, or other areas of high conservation or ecological value; refrain from dumping mine wastes into the ocean, rivers, lakes, or streams; ensure mining projects do not contaminate water, soil, or air with sulfuric acid drainage or other toxic chemicals; and cover all aspects of the closure and reclaiming of mine sites.

The rules also require mining companies to fully disclose information about the social and environmental effects of their projects, and allow independent verification of compliance with the golden rules.

"Target is proud to be part of the No Dirty Gold campaign," said Tim Mantel, president, Target Sourcing Services. "Our approach to sourcing products throughout the world is grounded in our heritage of strong business ethics."

EARTHWORKS said Target's pledge to abide by the Golden Rules "comes at a time when there is movement towards improved tracing and certification mechanisms for mine production."

The Golden Rules signatories have been committed to seeking third party certification of responsible mining practices when it becomes available. EARTHWORKS noted, "Discussions are advancing on third party certification...through the Initiative for Responsible Mining Assurance (IRMA)."

IRMA was launched in Vancouver in 2006 with the mission to develop and establish a voluntary system to independently verify compliance with environmental, human rights and social standards for mining operations. Participants include mining companies, jewelry retailers, NGOs and trade associations.

Best Buy CEO Dunn Reboots to Win Back Customers From Wal-Mart, Amazon.com

Bloomberg News
By Chris Burritt and Cliff Edwards

Best Buy Co. is rebooting -- again.

Concerned that consumers are coming to view the world’s largest consumer electronics merchant as just another big-box chain, Chief Executive Officer Brian Dunn is rethinking just about everything the Richfield, Minnesota-based company does.

He’s reorganizing the stores; new test locations in Pittsburgh and Las Vegas are less cluttered and bear more than a passing resemblance to Apple Inc.'s retail minimalism. Floor walkers have been retrained to show shoppers how gadgets work together -- a concept Dunn calls the “connected store.” The company is moving to “everyday” pricing, a guarantee that shoppers will get the lowest price Best Buy can offer.

“We have an industry that’s transforming, so naturally we’re transforming,” Dunn, 51, said in a telephone interview. “All of those initiatives show how we are transforming to what our customers need and want from us.”

The connected store represents a midcourse correction for Dunn, whose previous strategy involved loading up stores with exclusive products, including an electric bike. Best Buy has since lost customers to Apple, Amazon.com, Wal-Mart Stores Inc. and Costco Wholesale Corp., say analysts.

Tomorrow, when the company reports fiscal 2011 earnings, annual revenue may rise about 1 percent to $50.3 billion, according to analysts surveyed by Bloomberg News. That’s the slowest pace since 1990. Profit may rise 4 percent to $1.37 billion compared with a 31 percent increase the year before.

The connected store strategy won’t solve Best Buy’s challenges, according to Michael Pachter, an analyst at Wedbush Securities in Los Angeles who rates the shares “neutral.”

‘Irrelevant Solution’

“With the Internet and smartphones, we don’t need to shop at Best Buy to figure out which TV or electronics we want,” he said in a telephone interview. “Their solution may be good for 2011 but will be irrelevant by 2014. Technology is going to pass them by like they’re standing still.”

Dunn, who has been CEO since June 2009, is betting big on services. While trying to match the discounters on price, Best Buy aims to sell add-ons Wal-Mart and Costco don’t offer, including extended warranties, digital content streamed to devices and remote home-monitoring and repair, says Mike Vitelli, co-chief of the North American division.

Store No. 584 in the Pittsburgh suburb of North Fayette, Pennsylvania, provides a glimpse of Best Buy’s new direction. Gone are the tall enclosing shelves that have long typified the stores. Instead, a range of gadgets -- from tablets to cameras to digital photo frames -- are displayed on low tables. Shoppers get there via “the runway,” a stretch of blue tile leading from the front doors through the center of the store.

Saturday Workshops

As few as half of the store’s employees were trained to sell gadgets storewide. Now most are trained to sell across all categories. On Saturdays the store holds workshops. In one, a staffer demonstrates how to wirelessly display a photo on a TV.

“It used to be I could say, ‘This Blu-ray player can connect to the Internet and it can do Pandora and Netflix,’” said Mark Staub, a Pittsburgh store employee who oversees the displays of connected devices. “Now I can say, ‘Hey, let’s walk back there and I can show you how to do this.’”

Keen to reclaim customers who have defected to online retailers such as Amazon.com, Dunn is bringing the Web to the connected stores. Touch-screen kiosks allow customers to shop on bestbuy.com, print out price comparisons and see gift card balances. Just inside the front door, shoppers can pick up merchandise ordered online. Smartphone-packing salespeople check out customers right on the floor.

Geek Makeover

Best Buy’s Geek Squad is getting a makeover, too. Besides installing and repairing entertainment and computer systems in customers’ homes, the corps of technicians will staff consulting booths and troubleshoot and fix simple problems in the stores.

In the interview, Dunn acknowledged that the new stores look more Apple-like. Still, Best Buy didn’t take its cues from Apple, whose products it sells, says Ken Morris, field executive director for connected services.

“We heard from our female customers, ‘Lower your tables so we can talk,’” he said. “We’ve created a conversation.”

Dunn’s strategy to sell exclusive merchandise ran aground during the most recent holiday shopping season when Best Buy stocked 3D and Web-connected televisions for as much as $4,000 at a time when consumers remained budget-conscious.

Many flocked to discounted TVs at Wal-Mart, Costco and Amazon, and Best Buy’s third-quarter profit missed analysts’ estimates. In December, the retailer reduced its most bullish full-year profit forecast by 30 cents a share to $3.40, and the stock fell the most in eight years.

‘Out to Pasture’

According to the average of analysts surveyed by Bloomberg News, earnings will be $3.31 a share.

Best Buy rose 43 cents to $31.85 at 4:02 p.m. in New York Stock Exchange composite trading. Over the past 12 months the shares have fallen 23 percent, compared with a 49 percent increase for Apple and a 28 percent rise for Amazon.com.

With online retailers surging, Dunn’s latest strategy is like “re-arranging pictures on the wall of the stable with the horses already out to pasture,” said Colin McGranahan, an analyst at Sanford C. Bernstein & Co. in New York.

“You can have pretty stores,” said McGranahan, who rates the shares as “market perform.” “But with traffic declining, is it going to fix the problem? I am skeptical.”