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Introduction

In this article I'll have a closer look at Costco (NASDAQ:COST) which operates 648 warehouses, of which 2/3rds is located in the USA and Puerto Rico. I will provide my view on the financial results and the company's balance sheet. This will result in my investment thesis at the end of this article.

My view on the financial results

For the first quarter of financial year 2014 (Costco's financial years end in August), the company reported a revenue of $25B, which is a nice 5.4% increase compared to the same period last year. Fortunately Costco was also able to keep its costs under control, which resulted in the company posting an operating income of $668M, or 4.5% higher than the $639M in Q2 last year.


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Looking at the bottom line, Costco reported a net profit of $425M which equals $0.97/share (undiluted), which is just a 1% increase compared to the same period last year and a 6% miss on analyst expectations who were expecting the company to report a profit per share of $1.03. The main reason why the EPS increases by just 1% is the fact that the amount of outstanding shares of Costco has increased by 4.5 million, so the net profit has to be divided over more shares. The quarterly dividend remains stable at $0.31/share.

Unfortunately the company hasn't provided cash flow statements yet (nor in the press release, nor in the SEC filing), and that's a pity, as I always like to analyze the cash flow statements to determine the quality of the underlying business.

My view on the balance sheet

Moving over to the balance sheet, Costco had a working capital position of $2.6B, which is a very slight increase compared to the end of financial year 2013. The current ratio is an acceptable 1.17 (keep in mind a ratio higher than one means the company has sufficient current assets to cover its current liabilities).


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Again, it's too bad the company did not report a cash flow statement yet, as I was curious to see the impact of the $400M increase in property and equipment on the cash flow statements, as well as the $1.5B increase in merchandise inventories. This inventory buildup was very likely to have everything ready for Black Friday, which will be seen in the numbers of the second quarter of this year.

The equity side of the balance increased by $400M, which results in a book value per share of $25.62. This means that Costco Wholesale is trading at almost five times its book value, which is quite expensive, even for a growth company. It's even excessive if Costco is unable to turn the ship around, because based on the first quarter of this year, the net income growth is minimal and almost non-existing. But investors shouldn't overreact. Last year, Black Friday was included in the first quarter of the year (Nov 23rd) whereas Black Friday in 2013 will be added to the Q2 numbers. As such, I wouldn't panic yet, but instead wait for the numbers in the second quarter.

Investment Thesis

At first sight, Costco's Q1 wasn't exactly what everybody was hoping for, as the EPS increase was minimal and definitely didn't meet the average analyst expectations. However, I would like to emphasize that the first quarters of 2012 and 2013 aren't really comparable to each other, as last year the Black Friday sales were included in the Q1 2013 numbers, whereas Black Friday 2013 will only be added in Q2 2014 numbers which will be released in March next year. It's only then we'll be able to judge Costco's performance and to determine if the company's aggressive growth profile is still intact.

As such, it will be interesting to listen to the conference call later today where the management will very likely add more insight to the current quarter. I am a bit disappointed the management didn't issue a FY 2014 guidance, so it's quite difficult to look forward now as we can't be sure we're still on target to meet analyst expectations of an EPS of $4.93.

I think Costco is quite expensive at $120/share even if it's able to continue its growth path. It might be a better idea to write a long term out-of-the-money put option, such as a P100 January 2015 at $3.30. This would result in an annualized yield of 3%, which is approximately 3 times the current dividend yield of Costco.

Source: Costco - Black Friday Was Late This Year And Is Being Felt In The Financial Results