Costco: A Good Business at a Fair Price - Barron's

| About: Costco Wholesale (COST)
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COVER STORY: Everybody's Store by Andrew Bary

Summary: Costco Wholesale Corp. (NASDAQ:COST) continues to capitalize on its "treasure hunt" atmosphere, bulk pricing, and customer and employee loyalty. Charles Munger, a Costco director: "Costco has figured out the big, simple things and executed with total fanaticism." CEO Jim Sinegal earns just $350,000 according to his one-page contract that's renewed yearly; he believes the Board should evaluate him annually, and feels the restrained terms of his contract send a message to employees. He tries to visit each of its stores twice yearly. Costco's low margin is legendary (operating margin is < 1%), and reflects its commitment to low prices. This has lead to some Wall Street criticism -- if Costco were to raise margins to the same level as Sam's, EPS would rise about 25% instantly -- but many shareholders, including Davis Selected Advisors (its biggest shareholder at 12%) are happy with its focus on long-term customer satisfaction over myopically focusing on quarterly earnings. Despite its $50 yearly fee, which generates almost 70% of its current $1.75 billion earnings, renewal rates are an exceptional 87%. Workers like their higher-than-average salaries and 90% health-insurance coverage; they reward the company with a 6% employee turnover, $500,000 in sales per employee-year (1/3 higher than Wal-Mart Stores Inc. (NYSE:WMT)), and the industry's lowest shoplifting rate (0.2% annually). EPS have grown annually 12% over the past five years; analysts say that can go much higher if the company gets more aggressive in share-repurchases. At a current $56, shares trade at 22x 2007e earnings, one of the highest ratios in the industry, but calling to mind one of Buffett's dictums (he owns 5m shares): I'd rather buy a good business at fair price than a fair business at a good price. Barron's: "Margins probably have only one way to go -- up. In time, the shares are likely to follow."
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Costco Wholesale 11 02 2007