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THE COMPANY
BUSINESS SUMMARY
Costco Wholesale Corporation opened its first location in 1983 in Seattle, Washington under the name
Price Club. Originally serving only small businesses, the company found it could achieve far greater
buying influence by also serving a selected audience of non-business members. Costco became the first
company to ever grow from zero to $3 billion in sales in less than six years. Costco is a membership
based warehouse club, dedicated to bringing members quality brand-name merchandise at competitive
prices. In addition to the 4000 products they carry, Costco also offers the convenience of specialty
departments and exclusive member services. This multi-billion dollar global retailer has 698 warehouses
in 43 states and is now operating in eight countries.
PRIMARY MARKET
Costco Wholesale Corporation trades on the NASDAQ Global Select market under
the symbol COST.
2014
Foods
22%
22%
Sundries
21%
21%
Hardlines
16%
16%
Fresh Foods
14%
13%
Softlines
11%
11%
16%
17%
(1) Table 1.1 under Notes includes the subdivisions and components of each major category.
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The ancillary businesses offered by COSTCO expands the products and services
offered to members. These businesses encourage members to shop more
frequently and for a wider variety of goods and services. The following table
indicates the numbers of ancillary businesses in operations for the respective fiscal
years.
2015
2014
Food Courts
680
657
Optical Dispensing
Centers
662
641
Photo Processing
Centers
656
622
Pharmacies
606
565
581
502
Gas Stations
472
414
Number of
warehouses
686
634
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create inability, hardship, or delay in establishing new warehouses in suitable
locations, but also increase the costs of doing so.
With the plan to expand there is the risk of cannibalization. A new warehouse may
draw members from existing warehouses and affect the sales performance of such
stores.
Costcos expanding plans not only consist of opening new warehouses, it also
involves entering new markets. Failure to attract new members due to the lack of
familiarity with Costco is a potential risk faced by this type of expansion. Another
present risk is the competition Costco will face in the new markets it decides to
enter. Competitors might be larger and have an established market presence. Due
to these risks the future profitability of Costco can be delayed or materially
adversely affected.
Membership renewals and consumer loyalty are an essential component of
Costcos business model and growth. If Costco fails to maintain a positive
membership loyalty and brand recognition the results of its operations and its
growth potential could be negatively affected.
In addition damage Costcos private label, Kirkland, the brands it carries, and its
reputation could substantially impact member trust and loyalty, which in effect
would impact net sales and membership renewal revenue.
The extensive dependence on computer systems to process transactions, manage
business and inventory could pose substantial risks to the company in case of
failure or disruptions to the system.
Privacy and security breaches of members and other related business information
could damage Costcos reputation and substantially add costs and become subject
to litigation.
Payment related risks. Given the wide variety of methods of payments there is a
higher risk for fraud losses.
General economic factors, domestic and international financial and economic
conditions may affect business and results of operations.
Costco relies heavily of the efficiency of its vendors. Any delay or failure to deliver
or provide the necessary items and merchandise can have a potential impact in
Costcos inventory, operations, and financial conditions.
Fluctuations in foreign exchange rates may adversely affect our results of
operations.
Natural disasters could negatively impact the financial health of the company. As
well as the physical conditions of its warehouses and depots.
Failure to meet market expectations for financial performance could substantially
affect market price and the volatility of Costcos stock.
Significant changes in, or failure to comply with, federal, state, regional, local and
international laws and regulations relating to the use, storage, discharge, and
disposal of hazardous materials could potentially impact business and the results of
operations.
Costco is involved in a number of legal proceedings and audits and some of these
outcomes could adversely affect their business and result of operations.
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BUSINESS MODEL
SWOT ANALYSIS
WEAKNESSES
STRENGTHS
Pricing Authority: Costcos history
shows that they are committed to
provide its members with quality
goods at the most competitive prices.
Their efforts dont focus on
maximizing prices in the short term,
but instead they try to maintain a
perception among its members of
being a price leader.
Brand Loyalty: Because Costco
continues to offer high-quality
products and at great prices it has
created a very loyal customer base.
This has allowed the company to grow
market share and increase its
customer base over the years.
OPPORTUNITES
THREATS
Attracting Younger
Customers: Costco has taken several
steps to attract a younger audience,
between the ages of 19 and 34. This
effort would help to drive longer-term
sales and earnings at Costco. Costcos
efforts include: offering services such
as Google Express and InstaCart in
order to enhance their shopping experience
by making it more convenient, offering
better, higher-quality business
apparel, using promotions such as
Living Social, and offering more
organic foods. As a result of these
moves, Costco has been seeing a
larger percentage of new sign-ups
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Ancillary Business
Revenue
120
U.S. Core
Merchandinse
Revenue
100
80
60
International
Revenue
40
Membership
Revenue
20
0
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Costco also partnered with the health care service company Aetna to offer health
insurance services to its members. The program designed by Costco, The Costco
Personal Health Insurance, offers five Aetna health plans with key medical benefits
and dental coverage.
GROSS MARGIN
(1)
ANALYSIS:
Costcos gross margin has had little fluctuation over the past five years.
However, it had a significant increase in 2015.
Gross Margin %
13.20%
13.00%
13.00%
12.80%
12.60%
12.60%
12.60% 12.60%
12.40%
12.40%
12.20%
12.00%
2011
2012
2013
2014
2015
2014 VS 2013
The increase in gross margin in 2014 was primarily the result of an increase in
soflines, food, and sundries segments. During this year fresh food also had a
positive impact in gross margin.
The gross margin percent had an improvement of 4 basis points. The majority was
due to a price deflation of gasoline. If this impact is excluded, the majority of the
increase came from warehouse ancillary operations, and was negatively impacted
by a LIFO charge of higher inventory costs in the foods and fresh foods sections.
Leading to a gross margin percent change of 1 basis point.
___________________________________
(1) Calculated as a % of core merchandise sales, not total sales.
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Gross Margin %
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
2011
2012
Costco
2013
Walmart
2014
2015
Target
members quality products at the most competitive prices their focus shifts away
from short term price maximization charges. Instead they strive to maintain their
pricing authority through several strategies. This strategies include the reduction
of prices on merchandise to drive sales, and holding prices steady regardless of
cost increases. These strategies that Costco chooses to implement in order to
operate in accordance with their philosophy impacts their gross margin as a
percentage of sales in a negative way.
Another big factor affecting our gross margins are labor of costs. Costco is known
for not minimizing wages and benefits received by their employees. This concept
can implicate a greater absorption of labor costs when compared to other
companies in the industry. However, this implication is partly offset by their low
employee turnover ratio, and the shorter operation hours that Costco has.
One of the business sectors that has a big impact in Costcos gross margin ratios is
the gasoline business. When compared to the other segments, the gas segment
has a lower gross margin percentage. A higher penetration of gasoline sales will
generally lower their gross margin percentage.
Costcos gross margin percent is also impacted by competition and the change in
currency rates. The industry in which Costco competes is vigorous and widespread,
across a wide range of global, national and regional wholesalers and retailers.
However, Costcos response to this factor has been its effective business
adaptation to the changes in the industry. Some of the techniques Costco has use
to adapt have been through adjustment pricing and merchandise mix. Like
competition, the change in currency rates has a big impact in the gross margin for
each fiscal year. However, the currency exchange rates is a factor that Costco
cannot control.
Even though there are several factors that can negatively impact Costcos gross
margins the company has been successful in offsetting this financial adversities.
Given the fact that Costco offers items in limited quantities it is able to perform
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under a rapid inventory turnover rate. This rapid inventory turnover rate
combined with the operational system of volume purchasing, self-services
warehouse facilities, efficient distribution, and reduced handling
merchandise costs allows Costco to operate profitably at a significantly
lower gross margin rate than its major competitors.
Also, higher comparable sales (1) (excluding changes in cost of gas and fluctuations
in currency exchange rates, and associated competitive conditions) allows Costco
to reduce certain selling, general and administrative expenses as a percentage of
sales and enhances their profitability.
Finally, a big contributor to their gross margin is the revenue created from
membership renewals and sales. The growth in this area can have a great impact
not only in their margins, but also in their growth.
___________________________________
(1) Comparable sales are defined by Costco as sales from warehouses that have been opened for more than
one year. These sales are increased through higher shopping frequency and the increase in average ticket
amount.
Net Income
Net Sales
120000
2500
100000
2000
80000
1500
60000
1000
40000
500
20000
0
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2011
2012
2013
2014
2015
NET SALES:
2015 4th Quarter: Net sales during the 4th quarter were lower than those of the 3rd
quarter by a 23.91%.
Year of 2015: During 2015 an increase of 3% of net sales was attributable to the
operations at new warehouses opened in 2014 and in 2015. 1% net sales increase
was attributable to the sales of comparable warehouses.
NET INCOME:
2015 4th Quarter: Like net sales the 4th quarters net income was lower. It went
from $767 in the 3rd quarter to 487 in the 4th quarter. This was a drop of 36.51%.
Year of 2015: increased by $319 million dollars. This is equivalent to %5.37 per
diluted share. The results of 2015 were positively affected by a tax benefit in
relation to a special dividend paid.
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Warehouses in Operation
700
680
660
640
620
600
580
560
540
2011
2012
2013
2014
2015
Memberships
Gold Star Members
Business Members
40000
30000
20000
10000
0
2011
2012
2013
2014
2015
WAREHOUSES IN OPERATIONS:
Quarterly: N/A
Year of 2015: Costco continued to open new locations worldwide during 2015. 23
new locations were opened, 12 of those were established in the U.S., 1 in Canada,
and 10 in international markets.
MEMBERSHIPS:
Quarterly: Membership revenues were also lower in the 4 th quarter. A total of $785
million was reported under the 3rd quarter, while only $593 million were reported
under the 4th quarter. This was a drop of 24.46%.
Yearly: The 2015 annual fee $55.00. The renewal rate was about 91% in North
America, and 88% worldwide. The majority of members renew within 6 months of
their renewal date. Both types of memberships can be upgraded to an Executive
membership for a $55.00 fee. This fee pays a 2% reward to executive members.
39% of cardholders are Executive members. These members generally have
higher ticket average amounts.
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Net sales along with net income have continued to increase over the past five
years. However, the percentage of sales growth has decreased over these period
of time. From 2012 to 2013 there was a grow in sales of 11.50%. However, in 2015
the growth in sales was only 3.13%. Unlike net sales, net income has had relative
higher growth rates over the last five years. Yet the rates of growth in net income
did not follow a pattern like sales did.
Memberships and the number of warehouses in operation both continued to
increase over the past five years. This is due to the plans of expansion that Costco
has been implementing. Both of this sector are linked together given the fact that
an increase in membership revenue is a fundamental contributor to the expansion
of warehouses.
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COMPARATIVE DATA
PRODUCT DIFFERENTIATION:
CostcoProducts offered: Costco offers members low price on a limited selection of private
label and branded products in high volumes.
Floor plans: Floor plans designed to use selling space economically and efficiently.
Warehouses are about 144,000 square feet.
Hours of operation: Costcos hours of operation are shorter than other retailers.
This creates lower labor costs in relations to sales volume.
Average items carried: Costco carries an average of 4000 items.
Membership based.
WalmartProducts offered: Walmart offers its customers the lowest prices in the market for
general merchandise. Like Costco, it also has its own brand/s.
Floor plans: Super centers are about 187000 square feet in area.
Hours of operations: The majority of supercenters open 24 hours.
Average items carried: 142,000 different items
Labor: an average of 350 or more employees.
Sams Club:
Products offered: Like Costco, Sams Club offers merchandise that is selected and
from private levels at competitive prices.
Floor plans: Generally 132000 square feet in area.
Hours of operation: Sams club, like Costco, has hours of operation that are shorter
than other retailers. Generally operates between 10:00am-8:30pm.
Average items carried: 5500 products
Labor: 160-175 employees
Membership based.
Target:
Products offered: Target offers a wide assortment of general merchandise and
food. Like Costco, Walmart, and Sams it has its own label/s.
Floor plans: They vary per location.
Average items carried: N/A
Labor: 347000 full time employees.
business to break into. Not only does it demand a strong and substantial amount
of investing capital, it requires an effective strategic design and plan of entry and
survival. There are a lot of factors that contribute to the survival and the success
of a company like Costco and its competitors. Effective suppliers and designs of
distribution and transportation systems, operating efficiencies, strategic
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warehouse set ups and labor operations are some of the many necessary factors
to enter and survive in this industry.
also acts as a risk driver. While Costco focuses on finding and offering a limited
selection of products at competitive prices other warehouse retailers might be able
to offer similar products at lower prices.
power in the sense that Costco relies heavily on them to provide its members a
wide range of limited merchandise and private branded goods. However, Costcos
operating nature, they proven to find and stablish successful supplier relationship.
Costcos flexibility in products offered, the amount of time for which they are
offered, and the volume at which they buy and sell has proven an effective
counterpart of this bargaining power that the suppliers have.
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RATIO ANALYSIS
ROA: Even though Costco does not have the highest return on assets
among its competitors it has a pretty nice ratio. It is also important to take
into account that Walmart is a bigger company and the parent company for
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Sams Club, which is relatively similar in size to Costco. Therefore, its need
for investment in noncurrent and current assets will differ from Costco and
Target as well substantially.
ROE: All three companies have pretty good ratios, the all stand nicely within
the 15-20% range. Unlike return on assets, we see Costco in the lead with a
higher return on equity ratio. We can partly attribute this nice ratio to the
expansion projects that Costco has been undergoing in the past five years.
Relatively speaking Costco is new compared to Walmarts operational
history. Therefore, we can still find Costco in a growing stage in which
investors money has greater use for investments. Another important factor
to keep in mind is the variations in calculations of this ratio and the fact
that the debt to equity structure of the company has a big impact in this
number.
ROIC: Costco has a cost of capital of 8.10%. When compared to its return on
invested capital, of 13%, we see that it has a nice difference of 4.9 %. This
lets us know that Costco is performing efficiently and has been investing in
projects that are generating additional income, creating value. A higher
ratio of ROIC when compared to the WACC lets us know that Costcos has a
good financial performance.
EPS and P/E: Costcos price to earnings ratio is substantially higher than it is
for its competitors. Investors would have to pay a minimum of $12.82 to
earn $1.00 if they were to invest in Costco. However, it is important to
consider that its EPS is the highest of the three. Therefore, the high price to
earnings ratio is a result of Costcos higher market value per share when
compared to Walmarts $69.00 and Targets $82.54.
Measuring financial risk and debt to equity mix
Debt/ Equity: This is a nice ratio to get a quick picture of the mix between
equity and debt. However, it is important to notice that operational liabilities
are taken into account when calculating the ratio. Therefore, the ratio does
not represent a pure relationship of equity to debt. Under Costcos ratio we
can see that 59% debt is used to finance their assets. Costcos ratio is fairly
similar to Walmarts. However, Targets seems to be way above the two.
Along with its debt ratio, Target seems to have a high leveraged position in
comparison to Costco and Walmart, making it appear as a riskier company.
Debt/Capital: Costco has a pretty nice debt to capital ratio. According to the
ratio 37.30% of its capital comes from debt leaving a 62.70% of equity
financed capital. This is a good simplified representation of their debt to
equity mix. Along with the other long term solvency ratios, Costco seems to
have a pretty balanced level of leverage in relation to its equity. Walmart
shows a pretty similar debt to capital ratio. Overall, it seems to also have a
nice mix of equity and debt. Targets debt to capital ratio, along with its
other debt ratios, seems to be slightly higher. Overall, Target seems to have
more leverage than its two other competitors on the table. However, a
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closer look at their capital structure and optimal mix would paint a clearer
picture of their long term solvency status.
Total liabilities/ Total assets: This ratio gives us a nice simplified picture of
the companies leverage. Overall Costco has the biggest debt ratio when
compared to Walmart and Target. In this case, a higher Debt ratio indicates a
riskier position for investors given that this represents a greater leverage.
However, it is important to consider that this ratio is not a pure measure of
debt, it includes operational liabilities in the calculation. It is also important
to consider that, like in Costco case, if the company is generating returns
about its cost of capital then investors will are benefited. Overall, the ratios
of these three companies are pretty similar, which is greatly influenced by
the fact that they are operating in the same industry under similar demands.
SALES
2016
$117,075.98
3.0%
2017
$120,096.54
2.60%
2018
$122,654.60
2.10%
2019
$125,107.69
2.0%
2020
$127,084.39
1.6%
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GROWTH RATE
2015
16%
2016
14%
2017
14%
2018
14%
2019
12%
2020
8%
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$4864 million
$1283 million
N/A
Market Capitalization
Cost of Capital = Stock price x number of shares outstanding.
$66483.82
= $151.43 x 439.04
Weights
Total Capital =
4864+1283+66483.27
=
$72630.82
$4864/ $72630.82=
0.0670
$1283/ $72630.82=
0.0177
Equity =
$66483.82/
$72630.82=
0.9154
CAPM
CAPM= Rf + B(Rp)
Risk Free Rate
0.0265
Risk Premium
0.06
Beta
0.413
1 year
0.95
10 years
2.08
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Treasury
Yield
1.726
25
Cost of Long Term Debt = 10 year spread + 10 year treasure yield
RLTD = 2.08 + 1.726 = 3.806%
Cost of Short Term Debt=
WACC
Cost of Equity =
8.65%
Cost of LTD =
3.806%
Cost of STD =
1.363%
Tax Rate =
33.16%
WACC
(1)
Enterprise Value
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VALUE OF OPERATIONS
PRICE TO EARNINGS
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CONCLUSION:
Overall, Costco is in a face of growth that has allowed them to invest their capital
in an efficient manner, creating and adding value to their current operations. The
growth at which Costco has been expanding seems to be a pretty sustainable
growth. Over, the 5 year growth forecast, Costcos operations always resulted in a
surplus financing. This allowed Costco to pay a special dividend in the model each
year.
Costcos current mix of debt to equity is pretty close to the depicted optimal mix.
In most debt related ratios, it was evident that Costcos returns surpass its costs of
debt. Looking at the Ratio analysis section, it becomes clear that Costcos has
established a very efficient relationship between its equity component and debt.
The market value of Costcos shares efficiently depict its current expansion
achievements, and its future growth plans. One of the most, if not the most, crucial
components of maintaining this effective growth strategy is its membership driven
revenues. This is a clear and important indicator of how successful Costco is on
determining the right product mix, marketing campaigns, and attracting new loyal
customers. As long as the rate of new subscriptions and renewal rates continue to
increase, without cannibalizing away from existing locations, Costcos growth
potential is strong.
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NOTES
(1) Table 1.1
Foods
Sundries
Hardlines
Fresh Foods
Softlines
(2) Costcos shorter hours of operations, in comparison to other retailers, allow their
labor costs to be relatively low to their volume of sales.
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Bibliography:
Websites:
Our Retail Divisions. (n.d.). Retrieved April 04, 2016, from
http://corporate.walmart.com/_news_/news-archive/2005/01/07/our-retail-divisions
http://www.trefis.com/stock/cost/model/trefis?
easyAccessToken=PROVIDER_dddc0d73ad14bf1f1899d0bd953e2b691404dd86#
S&P Capital IQ McGraw Hill Financial. (n.d.). Retrieved April 04, 2016, from
https://www.capitaliq.com/CIQDotNet/Financial/Segments.aspx?
CompanyId=92817
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Costco Mortgage Review: What Don't They Do? (n.d.). Retrieved April 04,
2016, from http://www.thetruthaboutmortgage.com/costco-mortgagereview-what-dont-they-do/
Financial Documents:
Costcos Annual Report 2015
Walmarts Annual Report 2015
Targets Annual Report 2015
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