Costco Case Analysis

Angela (Sijie) Peng

Prof. Sasmaz

ACCT 414

October 10, 2016

Costco Wholesale Corporation Financial Analysis

Background

According to the case, “there was a rise of department stores and general merchants in the retail industry in the United States in the late 1800s. The 1960s witnessed a growth of discount stores, which focused on delivering items at the lowest prices. The early 1980s saw the introduction of wholesale club, which also delivered low price to customers but in large bulks. Founded in 1983, Costco was a major wholesale club with sales of $34 billion in 2001.”  Margarita Torres is an investor who has hold Costco Wholesale Corporation’s shares since 1997. From 1997 to 2002, Torres has witnessed the Costco’s warehouse expansion and revenue growth. Now Torres is curious about the reasons behind this rapid growth and if this trend can continue. This paper examines Costco’s financial performance in three parts: common size statements, sustainable growth model, and benchmarking ratios.

Common size statements

Common-size Income Statement Analysis

        Exhibit 9 is a common-size income statement which displays every line item on the income statement as a percentage of Costco’s net sales. This common-size income statement help us understand Costco’s profit structure and profitability progress from year 1997 to 2001. Costco’s total revenue, which is composed of net sales (98%) and membership fees (2%), has been increasing over the five years. Costco’s operating expense are mostly composed of merchandise costs (90%) and selling, general, and administrative costs (9%). From 1997 to 2000, Costco’s operating income and net income have fluctuated but showed a growth trend in profitability. However, there is a drop in operating income and net income in 2001. The 5-year average operating income is 3.08% of net sales and 1.72% of net sales.

Common-size Balance Sheet Analysis

         Exhibit 9 (Continued) is a common-size balance sheet which displays every line item on the balance sheet as a percentage of Costco’s net sales. This common-size balance sheet gives us an idea of Costco’s asset structure. The average 5-year current assets are 40.67% of total assets while the average net property, plant, and equipment are 55.53% of total assets. This balance sheet also tells us how these assets are funded. There is a growing trend in shareholders’ equity (from 45.07% to 48.39%) and a decreasing trend in total liabilities (from 53.32% of total assets to 50.46% of total assets).

Sustainable Growth Model

From year 1998 to 2000, Costco is growing at a sustainable rate. It is because that net sales and return on sales has increased steadily, ROA remained stable, and Costco has retained all its net income. However, Costco slowed it growth in 2001 due to a sharp drop in return on sales, ROA, and ROE.  

Profitability and earnings retention

        The stable 100% dividend retention rate indicates that Costco never pays dividends to its shareholders. Costco retains all its net income in order to grow its business rapidly. The decreasing ROE from 1998 to 2001 shows that Costco’s management is using investors’ money less efficiently.