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Deep discounting eats into Costco's holiday-quarter profit

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[March 07, 2014]  (Reuters) — Warehouse retailer Costco Wholesale Corp <COST.O> reported a bigger-than-expected 15 percent fall in quarterly profit as unusually deep discounting in the holiday shopping season hurt margins, sending its shares down as much as 3.6 percent.

Bad weather and six fewer shopping days between Thanksgiving and Christmas prompted many U.S. retailers to offer deeper discounts and increase promotions to lure shoppers.

Weaker gross margins, particularly during the holiday shopping season, and lower international profit due to a weakening of foreign exchange rates hurt earnings in the second quarter, Chief Financial Officer Richard Galanti said on a conference call with analysts.

Wal-Mart Stores Inc <WMT.N>, the world's largest retailer, last month blamed sharp cuts in food stamp benefits and higher payroll taxes for a disappointing full-year profit forecast.

At Sam's Club, Wal-Mart's warehouse chain that competes with Costco, sales at stores open at least a year — a key retail metric called same-store sales — fell 0.1 percent in the quarter ended January 31.

In contrast, Costco's sales at stores open at least a year rose 3 percent in the second quarter ended February 16.


The company's comparable sales rose 2 percent in February, missing the average analyst estimate of an increase of 2.3 percent.

Costco said February sales were hurt by club closures prevalent across the United States, Canada and even in Japan due to frequent snow storms.

Even so, Nomura analyst Robert Drbul said Costco's consistent low-mid single digit traffic gains over the last year in spite of the challenging retail environment was "particularly encouraging".

"We continue to believe the fundamentals of the company are intact," Drbul said.

The warehouse club operator, which offers discounted merchandise to members, said membership renewals had improved in the quarter.

"Our renewal rates continue at record levels and we continue to see increasing penetration of the executive membership," CFO Galanti said.

Executive members are the company's highest spending customers and represent about 38 percent of total cardholders. They pay an annual fee of $110 and are eligible for a 2 percent annual reward.

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New membership sign-ups rose 13 percent in the quarter, mainly driven by new stores in Japan and Australia.

"High renewal rates, strong new sign-ups and accelerating square footage growth for the next few years, all point to the secular strength of this story," Janney Capital analyst David Strasser said.

Costco's sales rose 6 percent to $25.76 billion in the quarter, missing the average analyst estimate of $26.65 billion, according to Thomson Reuters I/B/E/S.

Excluding fuel and forex, same-store sales rose 5 percent in the 12 week-period.

The company's net profit fell to $463 million, or $1.05 per share, in the quarter from $547 million, or $1.24 per share, a year earlier.

Costco has seen steady growth in sales since 2009 due to a continuing increase in its membership base, which saw 4.3 million new members signing up in 2013, according to research firm Trefis.

The Issaquah, Washington-based company's shares were down 2.4 percent at $113.65 in late evening trading on the Nasdaq. They fell to a low of $112.27 earlier in the session.

Costco's shares trade at roughly 23 times the company's expected earnings, well above the multiples for Wal-Mart Stores Inc <WMT.N> and Target Corp <TGT.N>, according to Thomson Reuters data.

(Additional reporting by Varun Aggarwal; editing by Gopakumar Warrier, Don Sebastian and Savio D'Souza)

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