COSTCO ESTIMATES TANK ON HIGH FUEL COSTS

Jon Springer

ISSAQUAH, Wash. -- Being the low-price leader in gasoline while fuel prices soar has come at an expense for Costco, executives of the warehouse club based here said.

Record-high gas prices in recent weeks have put margins under such intense pressure at Costco that the retailer revised its earnings estimates downward for its current quarter and fiscal year. Costco, which is scheduled to report third-quarter results on May 26, said earnings per share are expected to be between 41 and 43 cents for the quarter, and $1.88 to $2.04 for the fiscal year. Analysts' estimates compiled by First Call earlier this year pegged those figures at 47 cents and $2.11, respectively.

The vast majority of the earnings shortfall can be attributed to rising gasoline costs eating away at margins and profits, according to Richard Galanti, chief financial officer, Costco.

"Roughly 90% [of the shortfall] is margin-related, and of that 90%, 90% is gas-related," Galanti said in a conference call announcing the earnings revision. The remaining 10% is related to "little things that added up in the negative direction," he said, such as a slight increase in apparel markdowns and slow sales due to unusually rainy conditions in the Western states.

Volatility in the cost of gasoline has become particularly tricky for retailers like Costco, which rely on market-low retail prices on gas to attract traffic to its stores. Costco, which sells so much gas it must replenish its supplies daily, sees its profitability battered when its own gas costs rise, which has frequently been the case in recent weeks as prices set record highs. Competitors who can maintain a larger inventory of gas are better able to ride out that volatility, Costco officials said.

"Because we have so little gas in our tanks -- less than a day's supply -- when prices go up a nickel a day, we're getting hammered," Jim Sinegal, president and chief executive officer of Costco, said. "The fact that we're selling gas faster than anyone hurts us. A competitor nearby could have a week or two-week supply."

Costco could be paying as much as 10 or 20 cents per gallon more than competitors, but selling it at retail prices at or beneath theirs, Galanti explained.

Costco sells a little more than 100 million gallons of gas a month, Galanti said. Low fuel prices drive not only traffic to Costco stores, but help stores turn higher comparable sales and increase customer loyalty.

"Historically, what we've seen is that when you take an existing warehouse and put a gas station in the parking lot, you add 5% to 7% of sales to the warehouse in gas sales, and a couple extra percent of incremental business inside the building," Galanti said.

Rising prices will eventually find their way from the pump to the shelves, Sinegal said.

"At the moment, we definitely sense inflation, and a lot of that is driven by gasoline," he said. "Gasoline is a significant factor in getting goods to market, so everyone has to pay for it. There are also a lot of petroleum-based products. So I think we're going to start some price increases."

Galanti said he expected gas margin pressure would be worse than initially expected in the fourth quarter, which contributed to Costco lowering its earnings expectations during that period. But, he added, prices have been hard to predict week to week.