Gas Squeezes Costco Profit

"If we hadn't had this issue with our gas business in this quarter, we wouldn't be having this conference call because we would still be within the range that we had shared with you in early March," Costco CFO Richard Galanti told analysts listening in on the conference call. Fluctuating gas prices account for about three cents of the four-cent reduction in the company's expected per-share profit for the third quarter, Galanti said, attributing the remaining penny to "a lot of little things."

A chief reason that the gas business is hurting Costco is that the company always prices its gas lower than that of any competing station, although some competitors will sometimes match its price, Galanti and Jim Sinegal, Costco's president and CEO, pointed out. Sinegal explained that because the tanks at Costco stations hold only about a day's supply, in times of rapidly rising gas costs the company is paying higher prices for its gas while competing with nearby stations that bought gas at substantially lower prices a week or 10 days before. Competing station, he explained, have larger tanks that can hold a week or 10 days of supply. "When prices are going up a nickel a day, obviously we are getting hammered," Sinegal said. "Likewise, when they are going down, we are selling our gas faster than anyone else" and taking advantage of the falling costs, the Costco CEO said. The upshot of the ups and downs of the gasoline business and Costco's low-price policy is that the chain's profit on gas sales fluctuate from "close to zero to the mid-teens," according to Galanti.

Analysts focused mainly on the gas business in their questions Friday, but in answer to a question about Costco's grocery business, Sinegal said that although many of the supermarkets that Costco competes against "are now fighting to get back that share of market that they lost" during labor strikes, "Our level of competitiveness against the supermarkets is probably as good as it has been in the past." Costco has not had to lower prices in any category because of the supermarkets' efforts to regain market share, Sinegal said.

The company reiterated its previously discussed plans to open eight to 10 additional new warehouses before the end of its 2005 fiscal year and its estimate that it will open 25 to 30 new warehouses in its 2006 fiscal year, which begins on August 29. Costco operates 452 warehouses, including 334 in the US and Puerto Rico, 64 in Canada, 15 in the United Kingdom, five in Korea, four in Taiwan, five in Japan and 25 in Mexico.