Financial Analysis of Costco Company

Financial Analysis of Costco

Company Introduction to include: History, Sector and Competitors.

Costco was started from two different companies. One was started under the name Price Club (in 1976). While the other, was started under the name Costco in 1983. Price Club was created with the intention of serving as a whole seller to small business. However, after being open a short while, executives quickly discovered that they could sell their products to the general public for a small membership fee. When Costco began in 1983, they would focus on a similar kind of marketing strategy. Over the course of time, the two companies would quickly realize that they were selling the same products and following identical business models. As a result, Price Club would merge into Costco in 1993. Since that time, Costco has transformed itself by becoming one of the leading discount retailers. ("Costco History," 2010) the company is considered to be one of the largest retailers, by having both an online and offline presence. Inside the discount retail sector there are a number of competitors to include: Target, Wal Mart and BJ's Wholesale Clubs. ("Costco Wholesale," 2010)

Financial statement analysis to include the balance sheet, income statement and statement of cash flows. Do not give definitions of the statements - the reader has a full understanding of financial statements. Explain what has been happening financially with the corporation for the past several years.

When you look at the balance sheet, the income statement and the statement of cash flows over the last five years, Costco has been seeing consistently improving earnings. Part of the reason for this is because the recession has been pushing more consumers, to become price conscious. As a result, an increasing number are going to Costco in an effort to save as much money as possible. This has helped to cause the overall bottom line of the company to increase dramatically. Evidence of this can be seen by comparing net sales and net income with each other during this time. As the overall net sales would increase from: $51 billion in 2005 to $69 billion $70 billion in 2009. While net income would increase from: $1.03 billion to $1.068 billion. ("2009 Annual Report," 2010) This has been fueled by an aggressive push, from the company, to ensure that the majority of their members are renewing each year and the increase in the total number of stores open. When you put these different elements together, in comparison with the economic backdrop, they have helped contribute to the company's success over the last five years.

Ratio analysis from the financial statements. Need to have combined cross-sectional and time-series charts at a minimum the following ratios will be included: two liquidity, two activity, two debt, three profitability and one market (P/E).

The two different liquidity ratios that were used to analyze Costco include: the quick and the current ratio. The quick ratio for Costco is currently .6, while the current ratio is 1.2. What the different numbers are showing is that the company has enough liquidity, to be able to cover the short-term debt obligations facing the organization. ("Costco Wholesale," 2010)

The two debt ratios that were used include: long-term debt to total capital and total debt / equity. The long-term debt to total capital ratio is .17, while the total debt / equity is .20. The reading close to zero is indicating that the company has low amounts of debt in comparison with their assets. ("Costco Wholesale," 2010)

The three different profitability ratios that were examined includes: the gross profit margin (13.8%), the return on equity from operations (12.0%) and the return on assets (5.5%). When you look at these different numbers, they are indicating that the company is maximizing their profits (through the prudent utilization of resources and assets). ("Costco Wholesale," 2010)

The current PE ratio of the company is 23.5. This is above the average PE ratio for the last five years of 17.3. What this shows, is that the price of the stock may have become a bit expensive (as far as price is concerned) in comparison with traditional valuation methods. ("Costco Wholesale," 2010)

Application of risk measurement to determine stability of company portfolio. The past five years of returns will be calculated.

The different risk measurements for Costco (the beta) indicate that the stock is less volatile in comparison with the stock market averages (as the company is currently holding a beta of .78). Over the last five years the overall beta would vary dramatically as the price of the stock and the S&P 500 would go into a divergence. This would cause the beta to rise to as high as 1.00 during 2007. It would then begin to decline going into 2008 and 2009. This is because the prospects for the stock would improve, while the S&P 500 would go into a major decline. As a result, this would cause the beta factor (for Costco) to swing from .17 to 1.00 during that time. This is significant, because the risk measurement tools are showing, how the stock is able to with stand changes to the economy in comparison with the major market averages.

Bond valuation. The corporations assigned have long-term debt to ensure this can be accomplished.

Currently, Costco has low amounts of debt in comparison with their equity. As a result, the company has been given a rating of AA- from various rating agencies such as Morning Star. The total amount of debt in comparison to equity is 16.7% or $2.2 billion, while the equity is 83.3% or $10.8 billion. This is significant, because it shows how the company is in a strong financial condition, by maintaining low levels of debt. As a result, this is helping to contribute to the higher rankings that Costco is receiving for their outstanding long-term debt. ("Costco Wholesale," 2010)

Stock valuation. The corporations assigned have experienced dividend growth so that this model can be used.

Costco first started paying a dividend on May 6, 2004. Since that time, the amount that was being paid on a quarterly basis would continue to increase, with it currently sitting at $.25 cents per quarter. When you analyze the overall amount of growth that is being experienced from the current dividends, it is clear that they are paid based on the cash and earnings of the company. This shows how Costco can continue with the policy well into the future. As the dividends will see consistent payments, for shareholders and will more than likely be increased in the future. This is important, because it is a sign of the financial strength of the company. ("Costco Wholesale," 2010)

Determine the company's Weighted Average Cost of Capital, the cost of common stock and after-tax cost of debt must be included.

To determine the Weighted Average Cost of Capital, the cost of common stock and the after tax cost of debt requires looking at the DCF valuations of the company. Currently Costco has a Weighted Average Cost of Capital of 8%, the cost of the common stock is $71.25 and the after tax debt is 4.0%. This means that that company is in strong financial condition, by having low costs of financing, any kind of debt or equity offerings in the markets. To corroborate these different facts, the DCF is highlighting the underlying strength of the company with the stock: having a risk free rate of return of 5% and a risk premium of 4.5%. ("Costco Wholesale," 2007)

Determine the company's dividend policy.

The dividend policy of the company is to provide shareholders with a consistent quarterly dividend. This reflects the improving sales prospects for the company. A good example of this can be seen with the earnings that the company would post in first quarter of 2010. As sales would come in at $16.04 billion (up from $15.47 billion) and revenues would increase $16.39 billion (from $15.81 billion). When you compare this with increases in the dividends, it is clear that the company is setting them in comparison with their earnings results. As the yearly increases in earnings, will more than likely translate into an increase in the quarterly dividend that they are paying to shareholders. This is significant, because it is a sign of financial strength for the company. As the improving earnings and increasing dividends are highlighting how the business model is continuing, to support growth during the most challenging times. ("Costco Wholesale," 2010)

Conclusions

Clearly, Costco is a company that started out as a whole seller for businesses during the 1970's and 1980's. Over the course of time, this business model would continue to evolve, by offering memberships to the general public for a discount. This would create a shift in the organization itself, as it would continue to focus on addressing the needs of business, while providing a viable alternative for price conscious consumers. In many ways, one could argue that the company was at the forefront of trend that was just emerging in the retail sector (large discount warehouses).