California strike helps Costco reap rewards in first quarter - Southern California grocery workers

DSN Retailing Today, Jan 5, 2004 by Doug Desjardins

ISSAQUAH, WASH. -- A prolonged strike among Southern California grocery workers drove customers to Costco stores and helped the retailer post big gains in earnings and same-store sales during its first quarter. Those gains came despite weaker margins due to increased competition with Sam's Club.

Costco reported a 14% increase in net sales of $10.3 billion for its first quarter ended Nov. 30 and an 11% jump in same-store sales. Operating income increased by 7% to $254 million and the company posted earnings of 34 cents per share, 3 cents higher than analysts' estimates.

During a Dec. 9 conference call with analysts, Costco evp and cfo Richard Galanti said the effects of a strike among members of the United Food and Commercial Workers union in Southern California helped increase traffic in stores.

"More customers have been buying groceries at Costco to avoid picket lines," said Galanti. He estimated that the strike, which began Oct. 11, has generated an additional $60 million to $100 million in sales at Southern California stores and accounted for an extra 1 cent in earnings. The strike involves stores owned by Albertson's, Kroger and Safeway.

Same store sales in Southern California were up 10% in October and 11% in November compared to 8% in September and fresh food sales increased 20%. The lingering strike is expected to have a positive impact on sales in December and in January if it continues into next year.

Costco is also looking forward to getting some relief on escalating worker's compensation costs in California, which have been a financial drain on the company for years. Galanti said reforms passed last month by California lawmakers--including one that limits the number of times an injured worker can see a chiropractor--are "a step in the right direction" and should begin to lower costs in six to nine months.

Weaker margins were still an issue as Costco worked to keep pace with aggressive pricing in many markets at Sam's Clubs. Galanti conceded that margins have been reduced but said the overall affects have been overstated. "This was not a price war, it was increased price competition," said Galanti.

Looking forward, Costco plans to open 25 new stores during its current fiscal year and opened 11 new outlets in the first quarter. Galanti said Costco is likely to beat the 44 cents per share earnings estimates for the second quarter and expects full year earnings of $1.68 to $1.74 per share compared to an earlier estimate of $1.67.

Despite the strong first quarter performance, some analysts are concerned about margins and the long-term threat of Sam's Clubs.

Citigroup Smith Barney analyst Deborah Weinswig noted that "in our opinion, the revitalization of Sam's Club is still in its early stages and poses a competitive threat to Costco." She added that "we will continue to keep an eye on gross margin trends, as price competition with Sam's Club remains a key concern for us."