Company overview - Costco Wholesale Corporation is engaged in the operation of membership warehouses in the United States and Puerto Rico, Canada, the United Kingdom, Mexico, Japan, Australia, Spain, and through its subsidiaries in Taiwan and Korea. As of August 28, 2016, the Company operated 715 warehouses across the world. The Company's average warehouse space is approximately 144,000 square feet. The Company's warehouses on average operate on a seven-day, 70-hour week. The Company offers merchandise in various categories, which include foods (including dry foods, packaged foods and groceries); sundries (including snack foods, candy, alcoholic and nonalcoholic beverages, and cleaning supplies); hardlines (including appliances, electronics, health and beauty aids, hardware, and garden and patio); fresh foods (including meat, produce, deli and bakery); softlines (including apparel and small appliances), and other (including gas stations and pharmacy).
 

COST Details

Q3FY17 results driven by sales from new warehouses: During Q3FY17 (ended May 7, 2017), Costco Wholesale Corporation (Nasdaq: COST) reported 8% yoy growth in net sales to $28.2 billion, while net sales for the first thirty-six weeks grew by 6% yoy to $84.8 billion, driven by increase in comparable sales and sales at new warehouses opened since the end of the third quarter of fiscal 2016. During the quarter, net income for the quarter grew by 28.4% yoy to $700 million, compared to $545 million in the last year, positively impacted by $82 million ($0.19 per diluted share) tax benefit relating to the $7.00 per share special cash dividend announced on April 25, 2017, to the extent to be received by the Company’s 401(k) plan participants.  Net income for the thirty-six weeks grew by 12.1% to $1.7 billion, compared to $1.6 billion last year.  Moreover, during the third quarter of 2017, changes in gasoline prices positively impacted net sales by approximately $381 million, or 145 basis points, due to a 17% increase in the average sales price per gallon. However, changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $165 million, or 63 basis points, compared to the third quarter of 2016.


Income statement summary in Millions; (Source: Company reports)

The company has reported strong net sales of $12.2 billion for the month of June, an increase 7% from $11.3 billion during the similar period last year. For the forty-four weeks ended July 2, 2017, the Company reported 6% yoy growth in net sales to $104.9 billion, compared to $98.5 billion during the similar period last year.


Company’s food brands; (Source: Company reports)

Increase of annual membership fees:  Membership fees revenue increased 4% and 5% in the third quarter and first thirty-six weeks of 2017, respectively, primarily due to sign-ups at existing and new warehouses and increased penetration of higher-fee Executive Membership program. Notably, member renewal rates stood at 90% in the U.S. and Canada and 88% worldwide. Recently, the Company has increased annual membership fees by $5 for U.S. and Canada Goldstar (individual), Business, and Business add-on members (“Primary” Members) effective June 1, 2017. With this increase, all U.S. and Canada Goldstar, Business and Business add-on members pay an annual fee of $60. Further, annual fees for Executive Memberships in the U.S. and Canada increased from $110 to $120 (Primary membership of $60, plus the Executive upgrade of $60), and the maximum annual 2% reward associated with the Executive Membership increased from $750 to $1,000. The fee increases will impact around 35 million members, and roughly half of them Executive Members.


COSTCO Members as at Q3FY17; (Source: Company reports)

Expanding to other countries: The company has opened 16 new warehouses including two relocations in the first thirty-six weeks of 2017 and plan to open to 12 additional new warehouses for the remainder of fiscal 2017. This includes four warehouses in Other International operations, including two new countries, Iceland and France. In the first thirty-six weeks of 2017, spent approximately $1,723 million, and expect to spend approximately $2,500 million to $2,700 million during fiscal 2017. These expenditures are expected to be financed with cash from operations, existing cash and cash equivalents, and short-term investments.  Costco currently operates 732 warehouses (as on 2, July 2017) including 510 in the United States and Puerto Rico, 95 in Canada, 37 in Mexico, 28 in the United Kingdom, 25 in Japan, 13 in Korea, 13 in Taiwan, eight in Australia, two in Spain and one in Iceland.  Costco also operates electronic commerce web sites in the U.S., Canada, the United Kingdom, Mexico, Korea and Taiwan.


Country wise warehouses as at Q3FY17 (Source: Company reports)

Stock repurchase and Debt offering: Recently, the company announced the pricing of its offering of $3.8 billion aggregate principal amount of senior unsecured notes. The notes consist of the $1.0 billion principal amount of 2.15% notes due May 18, 2021, $800.0 million principal amount of 2.3% notes due May 18, 2022, $1.0 billion principal amount of 2.75% notes due May 18, 2024, and $1.0 billion principal amount of 3.0% notes due May 18, 2027. Costco used the net proceeds from the offering and existing cash to pay the special cash dividend of approximately $3.1 billion or $7.0 per share and to repay at or prior to maturity all its 1.125% Senior Notes due on December 15, 2017 in an aggregate principal amount of $1.1 billion with associated prepayment costs. Further, it has announced reauthorization of a common stock repurchase program of up to $4 billion. This program will expire in April 2019 and replaced the $4 billion program (expired in April 2017), which has unused authorization of approximately $2.5 billion.


Company’s financial position as at Q3FY17; (Source: Company reports)
 
Cash Flows driven by accelerated vendor payments: Cash flow from operating activities totaled at $4.8 billion in the first thirty-six weeks of 2017, compared to $3.4 billion in the first thirty-six weeks of 2016, primarily due to accelerated vendor payments of approximately $1.7 billion made in advance of implementing modernized accounting system at the beginning of fiscal 2017. Net cash used in investing activities totaled $1.5 billion in the first thirty-six weeks of 2017 compared to $1.3 billion in the first thirty-six weeks of 2016. Cash used in investing activities is primarily to fund warehouse expansion and remodeling activities, and includes purchases and maturities of short-term investments. Net cash used in financing activities totaled $2.1 billion in the first thirty-six weeks of 2017 compared to $2.1 billion in the first thirty-six weeks of 2016, primarily related to the $1.1 billion repayment of 5.5% Senior Notes on March 15, 2017. During the first thirty-six weeks of 2017 and 2016, it has repurchased 1,486,000 and 2,328,000 shares of common stock, at an average price of $156.51 and $148.64, totaling approximately $233 million and $346 million, respectively.


Cash flows as at Q3FY17; (Source: Company reports)

FY16 impacted by adverse currency movements:  During FY16, net sales increased 2% yoy to $116.1 billion, driven by sales at new warehouses opened in 2015 and 2016, while comparable sales were flat. Further, net and comparable sales were negatively impacted by changes in most foreign currencies relative to the U.S dollar. However, membership fee revenue increased by 4% to $2.6 billion, primarily due to sign-ups at new and existed warehouses and executive membership upgrades. Gross margin improved by 26 basis points to 11.35%, primarily due to the impact of gasoline price deflation on net sales. Net income declined by 1% to $2.3 billion, due to adverse movements in forex, largely in the Canadian dollar and Mexican peso.


FY16 financial summary; (Source: Company reports)
 
Stock Performance: The shares of COST have declined 15.5% in the last one month after the news of Amazon’s (NASDAQ: AMZN) acquisition of Whole Foods Market (NASDAQ: WFM), as it intensifies the further competition in the sector and pressure on operating margins. However, the stock has delivered 62% and 147% return over the past five years and ten years, respectively with stable dividend payments. The company continuous to earn higher profits while maintaining low prices and a cost leadership in the sector. Further, the company’s scale, unique product offering, brand and customer loyalty has positioned it as a low-cost and preferred player in the sector. Given the on-going investments in expansion of its new stores, and competitive advantage coupled with increasing product offers and cost efficiencies, we believe that the COST is well placed in the industry. We give a “Buy” recommendation on the stock at the current market price of $151.75


COST Daily chart; (Source: Thomson Reuters)
 

 
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