Seeking Alpha
Profile| Send Message|
( followers)  

Costco (NASDAQ:COST) as most people would say is a recession-proof business. It derives close to 56% of its sales from goods that do not fluctuate drastically with economic conditions: fresh food, non-alcoholic beverages, alcohol, tobacco, packaged food and cleaning supplies. With this product offering and annual membership fees from 67 million members, Costco has a built-in cushion that could weather out economic downturns.

Costco takes a very simplistic and minimalist approach to its business model. It is simply a large warehouse with crates of goods for sale. It charges anyone who wants to shop at their stores an annual membership fee of $55 and only accepts cash, debit and AMEX (NYSE:AXP). With AMEX, Costco pays very low interchange fees which adds to their bottom line. Any member can bring up to 2 guests with them, which is essentially free marketing for the company. The ideal outcome is that these guests will realize the cost savings achieved at Costco and become more inclined to purchase a membership for themselves. This membership fee is very important as it is the main contributor to the company's bottom line since sales excluding membership fees barely covers operating expenses. This means membership fees make up the majority of the company's profit demonstrating the beauty of this business model.

With most of Costco's products sold in bulk, it appeals mainly to suburban families and small businesses. Despite stagnant growth in family size in North America where they are predominantly located, they are continuously opening new stores year after year. They are beginning to branch out into Mexico which has an average household size of 4 (2010 - OECD Family Database) compared to the US which remains at 2.63 (2009 - US Census Bureau). This transition into a developing country that has increasingly more suburban communities may become very benefical to Costco. The challenge is expanding to countries in Asia such as Korea, Taiwan and Japan where they currently have a small presence. These countries are very dense (less suburbs), have decreasing household sizes and smaller physical households. Costco should focus on countries with large geographic areas, less population density and a growing or established middle class.

On paper, Costco has a fortress balance sheet. It currently has a debt-equity ratio of 0.11 which is significantly lower than its competitors: Target (NYSE:TGT), Dollar General (NYSE:DG) and Wal-Mart (NYSE:WMT). Its current ratio has remained over 1 and has continuously increased retained earnings for several years. With goodwill of $66m, it does not grow from acquisitions, but by organic growth. Costco has paid larger dividends each year since its first declared dividend and has made several stock repurchases.

Dividends:

FY 2012

FY 2011

FY 2010

FY 2009

FY 2008

FY 2007

FY 2006

FY 2005

FY 2004

$1.03

$0.89

$0.77

$0.68

$0.61

$0.55

$0.49

$0.43

$0.20

Stock Repurchases:

FY 2012

FY 2011

FY 2010

FY 2009

$ 523m

$ 400m

$ 358m

$ 0

Costco's management team has maintained a sound capital structure and has demonstrated a comprehensive allocation of cash flow towards dividends, stock repurchases and different growth opportunities.

Costco has been able to maintain many of its profitability metrics over the years.

In millions

2012

2011

2010

2009

Sales

$99,137.00

$88,915.00

$ 77,946.00

$71,422.00

Gross Profit

$12,314.00

$11,176.00

$ 9,951.00

$ 9,087.00

Operating Profit

$ 2,759.00

$ 2,439.00

$ 2,077.00

$ 1,777.00

Net Profit

$ 1,709.00

$ 1,462.00

$ 1,303.00

$ 1,086.00

Gross Margin

12.42%

11.27%

10.04%

9.17%

Operating Margin

2.78%

2.46%

2.10%

1.79%

Net Profit Margin

1.72%

1.47%

1.31%

1.10%

In millions except EPS

2012

2011

2010

2009

EPS

$ 3.89

$ 3.30

$ 2.92

$ 2.47

Net Income

$ 1,709.00

$ 1,462.00

$ 1,303.00

$ 1,086.00

Cash from Operating Activities

$ 3,057.00

$ 3,198.00

$ 2,780.00

$ 2,092.00

Capital Expenditures

$(1,480.00)

$(1,290.00)

$(1,055.00)

$(1,250.00)

Free Cash Flow

$ 1,577.00

$ 1,908.00

$ 1,725.00

$ 842.00

Despite being less levered, Costco is still able to generate a return comparable to its peers.

Most Recent FY

ROA

ROE

ROIC

Debt to EBITDA

Costco

6.56%

14.03%

12%

0.4

Target

6.48%

18.71%

9.90%

2.5

Wal-Mart

8.79%

22.55%

13.10%

1.6

Dollar General

7.97%

17.58%

13.40%

1.5

Efficiency:

Another advantage Costco has over its competitors is its ability to operate efficiently and effectively with fewer employees due to its membership warehouse model. Costco and Target have approximately the same market capitalization, yet Costco employs less than half of the employees Target does.

Most Recent FY

COST

TGT

WMT

DG

Market Cap

40.80b

40.53b

253.12b

15.56b

Sales

99.137b

69.865b

446.95b

14.807b

Net Income

1.709b

2.929b

15.7b

767m

Employees

174000

375000

2200000

90000

M Cap/ Employees

234482.76

108080.00

115054.55

172888.89

Sales/Employees

569752.87

186306.67

203159.09

164522.22

NI/Employees

9821.84

7810.67

7136.36

8522.22

As a retailer, one of the most important ratios to analyze is its inventory turnover ratio. For the most recent fiscal year, Costco had the highest inventory turnover of 12.6. For several years now, Costco has maintained a higher turnover relative to its peers. As written in their annual statements:

"Because of our high sales volume and rapid inventory turnover, we generally sell inventory before we are required to pay many of our merchandise vendors, even though we take advantage of early payment discounts when available. To the extent that sales increase and inventory turnover becomes more rapid, a greater percentage of inventory is financed through payment terms provided by suppliers rather than by our working capital."

Most Recent FY

COST

TGT

WMT

DG

Inventory Turnover

12.64

6.23

8.69

5.36

Valuation:

Costco is a great business with millions of loyal customers, a strong balance sheet and the ability to generate substantial cash flow. With the recent decrease in price from its all-time high of $104.43, it may be the opportune moment to purchase a share of this business.

As of October 22, 2012

COST

TGT

WMT

DG

P/E Ratio

24.3

14.2

15.9

17.9

P/B Ratio

3.3

2.6

5.1

-20.2

Div Yield

1.16%

2.31%

2.10%

0.00%

P/S Ratio

0.41

0.61

0.55

0.99

EV/EBITDA

10.40

34.18

8.86

10.43

P/FCF Ratio

21.39

38.93

23.63

29.20

From a relative valuation standpoint, Costco leads its peer group with the lowest P/S, EV/EBITDA and P/FCF. At the same time, it currently has the highest P/E despite the 10% price decrease in the past few weeks. Given a steady earnings growth rate for the past four to five years, no trigger for greater growth in the near future and ratios close to historical levels, there is minimal potential upside growth at this moment. On the other hand, with an average annual EPS growth rate of around 16%, a steady dividend payout ratio of 26% and strong cash flows, there is more upside potential for dividend growth and the possibility of Costco joining the prestigious group of dividend aristocrats. Be patient, Costco is a great business to purchase, but not at its current market price.

Source: Costco Wholesale: Patience Is All It Takes