Costco Sees Margins Expand

ISSAQUAH, Wash. — Costco Wholesale Corp. here said last week its margins are continuing to expand, and it believes it still has room for more margin improvement.

“We've been smart about how we can improve margins without doing the wrong things, and notwithstanding the fact we're constantly the most competitive out there, we feel pretty positive,” Richard Galanti, executive vice president and chief financial officer, told investors in a conference call discussing results for the recently ended fiscal year.

He said gross margins in each of the company's four core categories — food and sundries, fresh foods, hard lines and soft lines — were higher year-over-year in the fourth quarter by an average of 20 basis points, “and with core gross margin increases averaging 14 basis points in the third quarter, the trend has been good the last few quarters.”

Asked about inflation, Galanti said he anticipates “a heightened level of inflation” during the next few months because of increased prices in corn, wheat, proteins and sugar.

“While these high levels of inflation should subside a bit, we're still expecting some inflationary pressures, depending on the food items, over the next several months, but a little inflation net will be OK.”

For the year, which ended Aug. 29, Costco said net income rose 20% to $1.3 billion, while sales climbed 9.1% to $76.3 billion and companywide comparable-store sales, excluding gasoline, increased 7%.

For the 16-week fourth quarter, net income was $432 million, up 15.5%, while sales grew 7.8% to $23.6 billion and companywide comps, excluding gas, were up 6%.

Excluding gas, U.S. comps rose 4% for both the year and fourth quarter, while international comps rose 19% for the year and 14% for the quarter.

Galanti said fourth-quarter comps for food and sundries were up in the mid-single digits, while fresh foods were up a little over 5%.

During the call, Galanti said Costco plans to accelerate store expansion, with 29 net new locations scheduled to open in fiscal 2011, compared with 13 facilities that opened in the just-ended fiscal year.

Of the 29 new stores, 16 will be in the U.S. and 13 overseas. The company said it has already opened one new location — in San Diego — with seven more set to open before Nov. 21, the day the first quarter ends: single units in Landover, Md.; Atlanta; North Georgia; and Alberta; plus three Chicago units.

During the call, Galanti responded to questions on several topics, including:

• On Costco's performance in Southern California: “If the average U.S. warehouse does $137 million annually, then the average in Southern California would be as low at $160 million, up to $250 million.

  “But two years ago, when comps were healthy for the company, that region was always a little lower because the stores are more mature and there's more cannibalizing.

  “Los Angeles has shown some relative strength in the last few quarters — it went from low to slightly negative comps at its trough in the last year and a half to a very slightly positive. But even though it has a plus sign in front of it, it's been tough to leverage those expenses. So while it's improving, it's certainly been our roughest region from an operating leverage standpoint.”

• On plans to expand the company's online business: “It's a nice, profitable business — a nice chunk of business — but I think foreign expansion, given its profitability, is probably more important in the next two years.”

• On plans to increase membership fees: “That [prospect] doesn't give us any concern because our renewal rates are so strong and our member loyalty is strong. That being said, we would wait awhile, given the economy. That doesn't mean forever, but we don't feel any pressure to increase fees. But over the course of the next few years, my guess is there's an increase.”

Q3 RESULTS