Company Review – Costco Wholesale Corporation

Company Profile: Costco Wholesale Corporation (COST)

Costco Wholesale Corporation (Costco) operates membership warehouses that offer a selection of nationally branded and private-label products in a range of merchandise categories in self-service warehouse facilities. The Company buys the majority of its merchandise directly from manufacturers and routes it to a cross-docking consolidation point (depot) or directly to its warehouses. Costco’s depots receive container-based shipments from manufacturers and reallocate these goods for combined shipment to its individual warehouses, generally in less than 24 hours. As of September 3, 2006, the Company operated 487 warehouses, including 354 in the United States and four in Puerto Rico, 68 in Canada, 18 in the United Kingdom, five in Korea, four in Taiwan, five in Japan and 29 warehouses in Mexico (through Costco Mexico, a 50%-owned joint venture).
 

Business and Management Review

1) Is the business simple and understandable?

Costco is in the business of selling wholesaled goods to consumers at discounted prices over department stores. The company buys the merchandise from the manufacturer at a significantly lower price due to the volume of purchase. They then pass along the savings to the consumers who must pay a membership due(s) in order to shop from the “club”. The concept behind the business is to sell in extremely large volumes due to the low item by item margin.

2) Does the business have a consistent operating history?

Over the past five years, Costco has experienced overall positive growth even during periods of extensive expansion of the company. Earnings have fluctuated somewhat during key years of heavy expansion; however, we feel that this is necessary for the company to continue to be the powerhouse wholesaler they currently are.  

3) Does the business have favorable long term prospects?

The main competitor for Costco is Wal-Marts’ Sam’s Club division. We feel that Costco offers a greater value to their consumers and will continue to see market share increase in their favor. Costco enjoys remarkable brand awareness for a retailer and the consumer enjoys the treasure hunt atmosphere of possible savings. These factors will drive Costco to become more efficient and profitability to increase as well.  

4) Is management rationale?

We are impressed with the board of directors and the vast array of individuals it contains. We feel that the board is acting in the best interests of shareholders, and thus have management that as well is acting in the same manor. We see no reason to have concern that management is out of line in any foreseeable detail.

5) Is management candid with its shareholders?

Costco has a detailed investor relations page that has the typical detailed information one would expect from a company of this size. The page is easily found on the company’s website, and the content provided does not lack of any material information.

6) Does management resist the institutional imperative?

Given the diversity on the board of directors and the checks and balances that are in place, we see no reason to have any concern on this point. We trust that management is acting in the best interests of the shareholders of Costco.

Financial and Value Review
 

Defensive:

1) Size of firm

Costco passes the market capitalization test, with the company having a market size of over $24 billion.

2) Strong financial condition

The current ratio of the company falls below 2 at 1.22, therefore failing this test as well.

3) Earnings stability

Costco has enjoyed positive net income for the past ten years and passes this test for the defensive investor.

4) Dividend record

The company has failed to pay consistent dividends for the past ten years and fails this test.

5) Earnings growth

Costco has increased its earnings per share by one third over the past ten years, and therefore, passes this test.

6) Price to earnings analysis

The P/E ratio for Costco is roughly 22 and falls above the benchmark of 20 and as such fails this test.

7) Price to assets analysis

The P/B ratio is 2.6 and fails the test of being below 2.5.

Conclusion:

Costco fails the test of being suitable for the defensive investor with only a score of three. Although, two of the tests Costco barely failed and this should be noted.

Enterprising:

1) Strong financial condition

The current ratio is below 1.5 and therefore fails this test.

2) Earnings stability

The company has enjoyed positive net income for the five years prior and passes this test for the enterprising investor.

3) Dividend record

Currently, the company pays a dividend and passes the test of dividend payment.

4) Earnings growth

Earnings are greater than five years ago which allows Costco to pass this test.

Conclusion:

Costco passes the test for an enterprising investor with a score of 4/5.

Valuation:
Our analysis computes a fair price of $43.40 which concludes on a pure valuation approach of an overpriced security as the current market price is roughly $53.
 

Opinion:
Given the fact that the company passes the test for the enterprising investor we would allow this security to be in out portfolio, but given the inflated share price at this time we would wait for a more attractive price. An approximate ten percent decrease in share price would be place Costco in a more suitable position for acquisition.

Neither of us held a position in Costco at the time of publication.  Also, please read our disclaimer and Our Methods.

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