Monday August 18, 11:09 AM
Why Price Clubs Are Feeling the Pinch
By
Pallavi Gogoi
In the current retail environment, some chains have become so afraid of scaring off shoppers that many of them are taking it on the chin when it comes to paying for higher costs of food, fuel, and household goods such as paper towels. "The worry is that
if they increase prices too much across the board outside of food, the drop in sales will be too great," says David Abella, a portfolio manager who owns several retail stocks, including Wal-Mart, at New York's Rochdale Investment Management. The fund manages $2.5 billion in assets.
Nowhere is this more apparent than in the warehouse club business. On Aug. 14, Sam's Club, the warehouse club division of Wal-Mart Stores (WMT), reported that profits declined 2.9%, to $432 million, in its second quarter ended July 31, down from $445 million in the same quarter last year. Sam's dismal earnings results came just weeks after rival Costco Wholesale (NASDAQ: COST - news) (COST) warned that it would fall well short [BusinessWeek.com, 7/23/08] of analysts' estimates of a $1-per-share profit. Sam's Club margins dropped 21 basis points in the quarter, much of that because of low profits from gasoline. "We like selling fuel at our clubs," says C. Douglas McMillon, CEO of the Sam's Club division of Wal-Mart. "However, most months we do not make a lot of margin on fuel." McMillon said higher prices in other areas like bakery, flowers, and paper goods added further pressure.
A $100 Billion Quarter
Parent Wal-Mart, with its reputation as a destination for low prices, has benefited greatly from consumers' fears about the economy. On Aug. 14 the behemoth retailer reported a 10.4% increase in sales, to $101.6 billion, in its second quarter. It was only the second time in the store's history that sales topped $100 billion in a single quarter. The first time Wal-Mart posted over $100 billion in sales was in the fourth quarter ended Jan. 31, 2008, and that included the crucial 2007 holiday season. Wal-Mart management is closely managing its inventory, which helped boost its gross margin by 32 basis points in the quarter. But executives are being extremely cautious and are expecting sales to increase by less than 2% in the third quarter, even though sales at U.S. stores that were open for a year or more were up a healthy 4.5% in the latest quarter. "Our customers represent a broad income segment, and they are all challenged today," Wal-Mart CEO H. Lee Scott said in
a conference call to discuss earnings. Wal-Mart shares edged 22% higher, to finish at 58 on Aug. 14.
Despite the profit struggles, sales at warehouse clubs have been humming lately -- Sam's Club's same-store sales in the last quarter rose 7.2%. Costco, which hasn't released its quarterly results yet, saw its same-store sales soar 10% in July, while BJ's Wholesale Club (BJ) reported its sales rose 16.7% in the same month.
Unlike previous years, however, higher sales today can cut both ways at warehouse clubs. The good news for the warehouse operators is that people are shopping there in droves, and more people shopping means more memberships. So, Costco, for instance, makes $50 for every family that signs up to become an annual member. "Membership dollars is income that flows straight to the bottom line," says Stephanie Hoff, senior retail analyst at Edward Jones in St. Louis. The bad news is that the warehouse clubs will find it hard to raise prices. That's because the whole point of shopping at a warehouse club is to get discounts. And today, when consumers are being weighed down by high prices for food and fuel, warehouse clubs are an attraction as a one-stop shop for basic goods. "If Costco or Sam's do anything to damage that price reputation that they have built, they will damage their long-term ability to get new members," says Hoff.
Zooming Cost of Staple Goods
What's worse is that the very items that people are coming in to buy -- from fuel to household items like paper towels -- are seeing some of the highest price increases at the moment. Gasoline prices have climbed about 40% from last year, and some foods have seen double-digit price increases [BusinessWeek.com, 4/11/08] -- eggs are up over 30%, bread is up 20%. At the same time, Kimberly-Clark (KMB), the maker of Huggies diapers and Kleenex tissues, recently said it expects cost inflation to rise to $900 million, more than doubling its original estimate for 2008 because of higher softwood pulp and oil prices.
Richard Galanti, Costco's chief financial officer, last month offered analysts an example of how his company has battled prices. Galanti said the company sold its basic rotisserie chicken for $4.99 for several years. But in April, Costco raised it to $5.49, and on July 21 hiked the price again, to $5.99. "In each instance of raising prices, we did it several weeks after our costs had gone up," said Galanti. He said that manufacturing and shipping have raised costs as much as 10% or more for several items in the store just in the past two months.
Food [fresh as well as packaged] and fuel together represent more than 65% of sales at warehouse clubs like Costco and Sam's Club, unlike other stores such as Wal-Mart, where the merchandise mix is broader, with 40% of sales coming from groceries. Clearly, the warehouse clubs do not want to hurt the core of their business. But as with the rising cost of a rotisserie chicken, warehouse retailers will at some point pass the bill to consumers.
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