Costco: Tough Times Ahead

Costco Wholesale Corp. (COST) again recorded the most impressive sales performance amongst its large box retail counterparts. The company continues to financially prosper from consumers seeking out retailer that offer a strong value proposition on food and general merchandise. Comps for Costco rose a strong 7.0% in December, supported by gains in both the average transaction value and guest frequency. International operations recorded a 16.0% comp increase or 5.0% in local currency. Key merchandise departments at Costco performed well, though we were concerned with another month of weakness in the jewelry category and renewed softness in houseware sales.

We have maintained our overweight recommendation on shares of Costco in recent months given the Company's competitive advantages relative to other retailers and signs of a strengthening gross margin trend. Although acknowledging the Company's best of breed status in its sector, we are downgrading our rating to Hold, citing: 1) valuation, 2) tough sales comparisons in calendar 2008, and 3) degradation in the purchase habits of U.S. consumers. The Company's comp comparisons heading into the warmer weather months do not get any easier, and the cycling of mid- to high-single-digit percentage gains will prove difficult as consumers tighten their spending this year. Moreover, we believe there could be an element of disappointment to Costco's fiscal 2Q earnings report as a result of significant gasoline price inflation and sales mix trends thus far in the period.

Brian Sozzi is a research analyst for Wall Street Strategies specializing in the apparel/hardline goods sectors of the retail industry. Routinely sought after as a trusted point of reference for opinions and insight on the global economy and retail sector stock evaluation, Mr. Sozzi is a frequent contributor to Fox Business Network, Forbes, Bloomberg, the Wall Street Journal, TheStreet.com, CBS MarketWatch, Reuters, Seeking Alpha, and the Associated Press.