3/1/2010
By Brian Sozzi, Research Analyst

Costco Wholesale Corp. (COST) announces its 2Q10 earnings on March 3 and in view of heightened market expectations going in, this report and subsequent forward-looking commentary by management must impress.  We have reason to believe that Costco will not let the market down, posting earnings ahead of consensus estimates ($0.72).  Our EPS assumption is $0.75.  We anticipate the following were key drivers of the quarter:

* Favorable currency translation; comps on a reported basis have averaged 22.0% the last four months.  Core international comps, or ex. currency translation, have averaged 8.3% during the same timeframe as the company continues to gain its share of the retail market in generally healthy U.K. and Canada.
* Improved sales trends in California (27% of annual sales).
* Improved sales trends in discretionary merchandise departments.
* Buying leverage over suppliers and success in higher margin departments usurping negative gross margin impact from higher gasoline sales and 2% Executive reward program.
* Efficiencies gained through management initiatives (for example, better package construction on private label goods).
* Share repurchases (coming into the quarter, Costco had $2.0 billion remaining for repurchase under a pre-authorized plan).

Costco shares trade on a PE multiple of 19.9x our FY10 EPS estimate of $3.01 (consensus: $2.91), roughly in concert with the nine-year average PE multiple, and a premium to our discount retail sector coverage average.  The relative premium of the stock could be explained by Costco's competitive advantages (buying leverage over suppliers, efficient business model, global diversification, strong management execution) and usually stable operations.  Justifying a higher PE multiple amidst a sluggish U.S. economic recovery is tough, but we do foresee earnings related catalysts moving into FY11.  They include a ramp in global new unit growth, stronger margins in non-food categories, and share repurchases.  We have raised our FY11 EPS estimate to $3.30 from $3.20 (consensus: $3.22). Valuing the stock at 21.0x that assumption, it brings our price target to $70.00 from $68.00.

End result: buy the stock

Brian Sozzi
Wall Street Strategies