A few days ago I watched this two-minute Business Insider video stating that both Costco (COST, Financial) and Sam’s Club’s memberships are worth the cost. As a nonmember of either, I figured dissecting Costco’s financial numbers briefly would be a good investment of my time.
As shown in the screenshot above from the video, Costco not only offers its members discounted groceries but also other consumer products that can be bought elsewhere (mortgage, securities and car insurance). According to Costco’s 10-K, the additional services offered are generally provided by third parties and vary by country and state.
Further, these additional services can only be claimed when either a Gold Star or Business paid cardholder upgrades to an Executive membership. Gold Star and Business memberships cost $55 a year and an upgrade to Executive membership would be another $55 for a total cost of $110 per year. Other perks included in the upgrade would be for its Executive member to “qualify for a 2% reward on qualified purchases (up to a maximum reward of approximately $750 per year), which can be redeemed only at Costco warehouses.” (source)
(Source)
Costco seemed to have more customers signed up each year with its Gold Star member package than its other offers. According to its annual report, 39% of Costco’s members were Gold Star members. Costco also appeared to have customer retention in its business model as it had a customer renewal rate of 91% in the U.S. and Canada and 88% on a worldwide basis. As of Dec. 31, 2015, the company had 698 locations worldwide; ~70% or 488 stores are located in the U.S.
(Costco Membership Numbers, 2015 10-K)
Costco was also candid in providing its sales segmentation. As can be observed in the image below, Costco has been achieving growing sales numbers over the past three years and was able to produce those numbers with a consistent contribution as percentage of sales coming from different categories.
(Costco Sales Segmentation, p. 7 of 2015 10-K).
Sales and profits (in millions)
Costco’s sales and profits had no direction to go but up. The company had five-year averages of 8% and 12% in sales and profits.
One heated discussion recently focused on a minimum wage hike. California wanted to reach the $15 minimum wage mark by 2022 (source) while other states, such as New York, aimed to reach this target earlier — by 2018 (source).
As of Jan. 1, these are the states that have been paying above the set minimum wage:
(Source)
Costco has already been paying its workers higher than minimum wage on average. Using Glassdoor as a reference accompanied by a rough estimation, Costco pays its workers between $13 and $14 per hour except for front-end supervisors who get ~$10 on top of their regular wages.
As can be quoted from Costco’s recent annual report about its employee salary expenses:
“With respect to expenses relating to the compensation of our employees, our philosophy is not to seek to minimize the wages and benefits that they earn. Rather, we believe that achieving our longer-term objectives of reducing employee turnover and enhancing employee satisfaction requires maintaining compensation levels that are better than the industry average for much of our workforce. … Because our business is operated on very low margins, modest changes in various items in the income statement, particularly gross margin and selling, general and administrative expenses, can have substantial impacts on net income.” (Costco 2015 Annual Report, p. 25).
Costco's SG&A expenses have been climbing over the past decade.
Interestingly, Costco has been growing this expense more than the yearly change in Consumer Price Index (CPI). The CPI is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care (Investopedia). All Urban Consumers: All Items (Percent Change) was used as CPI data in the above chart (source). In short, Costco keeps its employees happy monetarily.
Annual return
Costco had returned an annual average return of 18.6% in the past five years while the Standard & Poor's 500 returned 12.06%.
Dividend yield
Costco currently yields a low 1.06%. Further, the company is not known for paying out handsome dividends as shown in its 10-year history of dividend yield below.
Dividends and growth
Costco appeared to demonstrate wild dividend payouts in recent years. A dividend investor would rather be less confident in the company’s issuance secondary to fluctuating payouts. But reading through its financial statements made me think otherwise.
Net shareholder return payouts
Although the company does not provide attractive dividend yields annually, the company pays at least 50% of its profits to its shareholders on an annual basis.
Debt to equity and shares outstanding
Costco appeared to be disciplined in terms of not diluting its shareholders and instead buys back its shares regularly. However, in December 2012, Costco issued huge $3.5 billion senior notes for funding of its special cash dividend and share buybacks. Costco gave $3.6 billion in dividends while buying back shares at a cost of $36 million at an annual average price to earnings ratio of 25.6.
This debt issuance resulted in Costco’s debt-to-equity ratio jumping as shown above in its later 2013 fiscal filing. Costco’s long-term debt jumped from $1.3 billion in 2012 to $4.9 billion in 2013.
The company still had $4.8 billion outstanding as of the recent quarter. The value and expiration of the senior notes were as follows: $1.2 billion due Dec. 7, 2015 (0.65% notes); $1.1 billion due Dec. 15, 2017 (1.125% notes) and $1.2 billion due Dec. 15, 2019 (1.7% notes).
I am skeptical as to why Costco would have this "outrageous" special dividend occasion during those years. But then again, the company announced another "special dividend" in February 2015. The company said it aimed to enhance shareholders’ returns (source). Nevertheless, its debt ratio seems to remain at conservative levels despite these special dividend occasions.
Valuations
In terms of the traditional price-to-earnings and price-to-book value ratios, Costco currently trades at a premium compared to its peers and the S&P 500.
Conclusion
It was interesting to find out how a company would go to great lengths to satisfy its customers, shareholders and employees. Costco showed it can do so while keeping an army of 205,000 employees happy. As for now, I would be happy just watching the company and its shares from the sidelines.
Happy investing!
Mark
