Costco (NASDAQ:COST) is a leader in a market that is free of cyclicality. The company maintains a unique business model that requires its consumers to renew or purchase their annual memberships in order to make purchases at its stores. As distinctive and daunting as the membership requirement may sound, the 91% renewal rate is indicative of the fact that the company's unique business model is highly successful.
The company maintains a strong balance sheet with practically no short-term debt along with increasing revenues and cash flows. Costco's top line increased at a CAGR of approximately 10% over the past five years while the bottom line increased at a CAGR of 12% during the same time period. The improvement in revenues is primarily due to the increasing comparable sales which have shown significant improvements over time. The following figure shows the company's comparable sales, both adjusted and reported, during the past few months.
Source: Press Releases
As evident from the reported figures above, the forex has had a significantly negative impact on the company's comparable sales during the past two months. The adverse foreign exchange impact has depressed the company's overall comps figure. However, the company's US comparable sales continue to report a positive performance.
The company maintains a very strong balance sheet as Costco practically carries no short-term debt and even then boasts a better liquidity position than its peers. The company's current ratio presently stands at 1.22 compared to the industry standard of 1.19. However, the company's long-term debt to equity ratio trends higher than the industry average. Costco's long-term debt to equity ratio presently stands at 41.4 compared to the industry average of 37.18. Considering the fact that the company's cash flows from operations have increased at a CAGR of 9% during the past five years, debt payoff is certainly not an issue for the company. In addition to that, the debt is raised to finance the growth in business.
What Sets Costco Apart From the Others?
The company has considerably reduced the inventory levels at its stores and only keeps a select few brands. The company's success rate compels suppliers to fight for shelf space which in turn enables Costco to negotiate better terms. Limiting its inventory level also allows the company to benefit from a high inventory turnover ratio.
In addition, maintaining a higher bargaining power allows the company enjoy better profits and offer consumers discounted prices. The company has put an upper limit of 15% on the level of margin it is allowed to reap on any given product. This policy continues to draw more and more consumers to Costco's stores for purchases and helps it maintain high membership renewal rates.
Costco is very supportive when a customer does not like a product and wants to return it without asking questions. This policy has helped the company to retain consumers and returning to its stores. This policy is especially useful considering the fact that Costco spends zero dollars on marketing and is entirely reliant on word of mouth, which has proven to be the strongest marketing tool to date. In addition, the company knows that competent staff is a requirement to keep customers happy. The company pays its employees well, which is evident by the recent survey released by Glassdoor which puts Costco second to Google when it comes to rewarding employees. Almost all of the company's employees enjoy company-sponsored health insurance in addition to wages double the minimum wage rate. This is a major reason why the employee turnover at the company is minimal and the quality of service is top-notch.
Going forward, the company is expanding its business in different locations which justifies its growing long-term debt. In fact, the long-term debt may actually increase in the next few years as capital expenditure increases as part of this growth plan. Presently, Costco has plans to establish businesses in 31 new locations, 60% of which would be opened in the US to further its network in the region. Besides the US, three stores would be established in Korea; two each in Mexico and Japan; and one each in Canada, the U.K., Spain, Australia, and Taiwan. Presently, Costco has 663 warehouses worldwide and the new location openings would increase the number of warehouses to 694. The following figure shows the increasing number of locations worldwide.
Source: Annual Report, 2013
The expansion plans would require spending in excess of $2 billion per annum until FY2019. Note that the expenditure figure is only an estimate and may vary from the actual figure.
The company's share price has increased by more than 130% during the past five years thus substantially rewarding the shareholders.
In addition to a very significant price appreciation, the company rewards its shareholders through cash dividends as well. Although Costco's dividend yield of 1.03% falls short of the industry standard of 1.9%, the company paid a special dividend of $7 to its loyal investors. In addition, the company has maintained its share count to evade dilution of percentage holding.
The company has a very loyal consumer base and its consumer base will increase once Costco establishes its roots in new markets. Considering the fact that it benefits consumers by putting an upper limit on its margins and rewards its investors through various means, the company will continue to perform well in the industry and the stock market. Some analysts argue that Costco is relatively pricey at the moment but the stock is still a buy for long-term investors as its growth strategies will lead to tremendous returns to the shareholders.
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