Costco's Cookin' With Gas


This article is part of ourRising Star portfolio series.

Costco (NAS: COST) continues to deliver financial results and remains a favorite stock citizen in the Rising Star portfolio I'm managing for In fact, you could say Costco's cooking with gas.

The power of the pump
The lure of cheap gas attracted frugal shoppers to many Costco stores in the second quarter. Quarterly same-store sales rose 8%; stripping the effect of gas price inflation, comps rose by a still-impressive 7%.

Costco reported a perfectly decent quarterly profit, increasing 13.2% to $394 million, or $0.90 per share. Still, some folks found a bone to pick when it comes to eroding margins. But this is Costco. Costco's differentiator is offering items at rock-bottom prices; this is how it generates customer loyalty.

In the conference call, Chief Financial Officer Richard Galanti explained Costco's gross margin drop as an investment: "We continue to invest in price to strengthen our business long term. ... This [lower gross margins] continues to be due to our decision to hold prices on many items, even as some commodity prices have increased. You have heard that again and again. That is what we do." Although he was describing the strategy in ancillary business, he was clear that Costco conducts this in other areas as well.

In other words, analysts and investors: Get used to it. Costco builds its business for the long term, and it's going to hold out as long as it can in order to please its customers with low prices. Its strong second-quarter sales are testament to the strategy; revenue increased 10% to $22.51 billion. Costco's working to drive the top line and further addict its customers to its low-cost wares, and it's not the kind of company that lets Wall Street's short-term profit expectations get in the way of its business.

And Costco conducts its business very well.

When retailers reported February's same-store sales yesterday, discounter Target (NYS: TGT) reported a 7% increase, on par with Costco's monthly achievement. However, bear in mind that this is the biggest comps gain Target has mustered since November 2007. Last year this time, Costco's February same-store sales surged 8%.

Basically, the fact that Costco goes along and just keeps doing what it does is why it's been consistently reporting stellar results over the course of recent uncertain economic times.

By comparison, in late 2010, Wal-Mart's (NYS: WMT) situation was so desperate that it went against its own competitive advantage and started raising some prices to try to boost U.S. sales.

Method to the madness
Costco isn't the only stock I've purchased for the portfolio that's known for sacrificing margins in order to drive sales volume. This is one of's (NAS: AMZN) tricks, too, and that's been a pretty smart maneuver over the long haul, even if investors and analysts occasionally get worked up about the strategy in the short term.

I view Costco as one of this portfolio's stable stocks for the long haul; it's fashioned itself as far more than "just a retailer." Letting Costco do what it does best without sweating the short term is a great path to long-term performance.

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At the time thisarticle was published Alyce Lomax does not own shares of any of the companies mentioned in her personal portfolio. The Motley Fool owns shares of Wal-Mart Stores, Costco Wholesale, and Motley Fool newsletter services have recommended buying shares of, Costco Wholesale, and Wal-Mart Stores. Motley Fool newsletter services have recommended creating a diagonal call position in Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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