March 2, 2016
Costco Wholesale Corporation
(COST-NASDAQ)
$152.79
Note: More details to come; changes are highlighted. Except where highlighted, no other sections of this report have been
updated.
Reason for Report: Flash Update: 2Q16 Earnings Update
Prev. Ed.: Jan 8, 2016; 1Q16 Earnings Update
Flash Update (earnings update to follow)
On Mar 2, 2016, Costco Wholesale reported earnings of $1.24 per share that missed the Zacks
Consensus Estimate of $1.28 and also declined 8.1% from $1.35 posted in the prior-year quarter due to
higher operating expenses. Lower traffic count and foreign currency headwinds impacted the quarterly
results as well.
Delving Deeper
The warehouse retailer’s total revenue, which includes net sales and membership fee, rose 2.6% to
$28,170 million in the reported quarter. Quarterly net sales went up 2.6% year over year to $27,567
million, whereas membership fee increased 3.6% to $603 million. However, total revenue fell short of the
Zacks Consensus Estimate of $28,584 million, thus marking the fifth straight quarter of revenue miss.
Costco’s comparable-store sales (comps) for the second quarter inched up 1%, following a decline of
1% in the preceding quarter, reflecting a 3% increase at U.S. locations, partially offset by a 7% fall in
locations at Canada and a 3% drop at Other International outlets.
Excluding the effect of lower gasoline prices and currency headwinds, the company witnessed comps
growth of 5% during the quarter, with U.S., Canada and Other International comps registering an
increase of 4%, 10% and 6%, respectively.
Costco’s operating income in the quarter under review dropped 2.4% year over year to $856 million,
whereas operating margin (as a percentage of total revenue) contracted 20 basis points to 3%.
February Sales Results
Costco reported flat comps for February, following flat comps for January, an increase of 1% in
December, flat comps in November and a 1% decline in October. Comps for February reflect an
increase of 2% at the company’s U.S. locations, offset by a 2% fall at its Canadian locations and a
decrease of 8% at Other International locations. While lower gasoline prices impacted U.S. comps,
currency fluctuations adversely affected international comps.
However, excluding the adverse impact of foreign currency headwinds and gasoline price deflation,
Costco’s comps for the month under review rose 4%. The company recorded comparable sales growth
of 4% and 10% across its U.S. and Canadian locations, respectively, while comps at Other International
outlets remained flat.
© Copyright 2016, Zacks Investment Research. All Rights Reserved.
On the sales front, the company reported a 1% improvement in net sales to $8.28 billion for the fourweek period ended Feb 28, 2016.
Financial Aspects
Costco ended the quarter with cash and cash equivalents of $3,633 million and long-term debt (including
current portion) of $4,975 million. The company’s shareholders’ equity was $11,000 million, excluding
non-controlling interests of $234 million.
Let’s Conclude
Costco continues to be one of the dominant retail wholesalers based on the breadth and quality of the
merchandise it offers. Its strategy to sell products at highly discounted prices has helped in sustaining
growth amid soft economic conditions. Also, the company’s diversification strategy acts as a natural
hedge against risks that may arise in specific markets.
However, Costco faces stiff competition from Target Corporation and Sam’s Club, a division of Wal-Mart
Stores Inc. that follow a similar business model, which pushes through high volumes of merchandise at
low prices in membership-only warehouse clubs. Thus, aggressive pricing to gain market share and
drive traffic amid stiff competition, may depress sales and margins, going forward.
Costco currently operates 698 warehouses, comprising 488 warehouses in the U.S. and Puerto Rico, 90
in Canada, 36 in Mexico, 27 in the U.K., 24 in Japan, 12 in Korea, 11 in Taiwan, 8 in Australia, and 2 in
Spain.
Portfolio Manager Executive Summary [Note: only highlighted material has been
changed]
Costco Wholesale Corporation (COST), based in Issaquah, WA, operates membership warehouses. It
offers low prices to members on a limited selection of nationally branded and selected private-label
products in a wide range of merchandise categories. The company offers three types of memberships:
Business, Gold Star (individual), and Executive Membership.
Of the 21 firms covering the stock, 14 provided positive ratings and 7 assigned neutral ratings. None of
the firms rendered a negative rating to the stock.
The outlook of the firms on Costco is dealt with in the following paragraphs:
Positive or equivalent ratings (66.7%; 14/21 firms): Costco remains an investor favorite, given the
company’s potential to stretch its wings globally, the ability to enhance its market share in the food and
consumables categories, and deliver consistent comparable-store sales (comps) growth. Favorable
sales mix, strong value proposition, robust renewal rates, superior merchandising and focus on
expanding operating margins act as catalysts for the stock. The bullish firms believe that the company is
geographically well positioned which helps drive growth in both the foreign markets as well as the
thriving U.S market. Further, continuous investments in the foreign markets have been driving Costco’s
profitability. These firms also believe that the company’s compelling value proposition, consistent traffic
flow and loyal customer base will take it forward in the competitive retail world.
Costco has been witnessing impressive traffic, with its membership rate scaling new heights. Strong
new member signups, record-high renewal rates, increased penetration of executive members and
ongoing club expansion suggest continued healthy growth in the company’s membership fee stream.
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Additionally, these firms believe that the company’s merchandise margins are improving in almost all
categories. Moreover, a healthy balance sheet and significant cash flow generating capability facilitate
Costco to increase its store count, augment its dividend payout and increase its share repurchase
activities.
Neutral or equivalent ratings (33.3%; 7/21 firms): The cautious firms believe that Costco is a wellpositioned company in the warehouse club industry, backed by its robust membership renewals,
exclusive shopping venues and international expansion initiatives. Further, they think that the company
has plenty of room to expand its store base, both domestically and internationally. However, these prefer
to remain on the sidelines owing to Costco’s higher selling, general and administrative (SG&A)
expenses that may weigh upon its bottom line. In addition, the firms stated that the company’s shares
are trading at a premium to its peers, thereby limiting its upside potential. Though the firms think that
Costco’s prospects appear bright, taking into consideration its strong industry growth and market share
gains, these remain cautious due to the ongoing foreign exchange headwinds.
Another concern is Costco’s over-expansion in new domestic markets, which poses the threat of
cannibalization of existing stores. Moreover, club launches in new markets entail significant capital
investments and promotional expenses, which tend to strain margins.
Jan 8, 2016
Overview [Note: only highlighted material has been changed]
The firms identified the following factors for evaluating the investment merits of Costco:




Key Positive Arguments
It continues to be the dominant retail wholesaler
based on its breadth and quality of merchandise
offered.
Strong comps boost the company’s gross margins,
and in turn, bring in profitability.
Favorable sales mix, strong value proposition,
robust renewal rates and focus on expanding
operating margins act as catalysts.
A healthy balance sheet and significant cash flow
generating capability facilitate the company to
increase its store count and augment its dividend
payout.




Key Negative Arguments
Any decline in membership renewal rates would
negatively affect profit trends given the company’s
dependence on membership fee income.
Costco’s members are expected to sharply react to
macroeconomic factors like rising interest rates,
high household debt levels and a reduced net
worth caused by a decline in real estate value.
Accelerating square footage growth may
cannibalize sales.
The firms believe that fluctuations in consumer
spending, rising input costs and competitive pricing
can be a threat to the company.
Based in Issaquah, WA, Costco Wholesale Corporation sells high volumes of foods and general
merchandise at discounted prices through membership warehouses. It is the largest warehouse club
operator in the U.S. The company’s warehouses offer an array of low-priced nationally branded and
select private-labeled products in a wide range of merchandise categories. Costco offers three types of
memberships to its customers: Business, Gold Star (individual), and Executive. Costco generates
revenue from two sources: 1) Store sales and 2) Membership fee.
Costco offers a variety of food products as well as a vast range of household and lifestyle products,
stationeries and appliances. The company also sells gasoline to customers at cheap prices. The
company’s products are classified under six broad merchandise categories, namely,
1) Sundries (including candy, snack foods, tobacco, alcoholic and nonalcoholic beverages),
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2) Hardlines (including major appliances, electronics, health and beauty aids, hardware, office
supplies),
3) Food (including dry and institutionally packaged foods),
4) Softlines (including apparel, domestics, jewelry, housewares, media, home furnishings, cameras),
5) Fresh Food (including meat, bakery, deli and produce) and
6) Ancillary and Other (including gas stations, pharmacy, food court, optical, one-hour photo, hearing
aid and travel).
As of Nov 22, 2015, Costco operated 697 warehouses, comprising 487 warehouses in the U.S. and
Puerto Rico, 90 in Canada, 36 in Mexico, 27 in the U.K., 24 in Japan, 12 in Korea, 11 in Taiwan, 8 in
Australia, and 2 in Spain.
More information is available on the company’s website http://www.costco.com and http://www.costco.ca
in Canada. Costco’s fiscal year ends on Aug 31.
Jan 8, 2016
Long-Term Growth [Note: only highlighted material has been changed]
Costco continues to be a dominant retail wholesaler based on its breadth and quality of merchandise
offered. The company’s strategy to sell products at heavily discounted prices has helped it to remain on
the growth track amid beleaguered economic conditions as cash-strapped customers continue to reckon
Costco as a viable option for low-cost necessities.
The company’s diversification strategy is a natural hedge against risks that may arise in specific
markets. A differentiated product range enables Costco to provide an upscale shopping experience for
its members, resulting in market share gains and higher sales per square foot. Moreover, the company
continues to maintain a healthy membership renewal rate.
Costco continues to make prudent use of its healthy free cash flow through share repurchases and
dividend payments. This underlines its efforts to maximize shareholder returns under difficult economic
conditions. Moreover, the company’s current cash resources are reasonably adequate to support
expenditures associated with its ongoing expansion initiatives.
The firms remain encouraged by the company’s expansion strategy. Costco has one of the highest
square footage growth in the industry and remains committed to open new clubs in the domestic and
international markets.
The firms believe that the company’s growth prospects are strong, given its market share gains, strong
industry growth and store augmentation. These expect Costco to remain cautious about keeping its
product markups lower, so that it can retain customer loyalty, which in turn provides the company with a
long-term competitive edge over other retailers. The company also has a solid financial position, backed
by a strong balance sheet along with healthy cash flows, which facilitate it to further store expansion and
pay high dividends, thereby enhancing shareholder value.
Jan 8, 2016
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Target Price/Valuation [Note: only highlighted material has been changed]
Rating Distribution
Positive
66.7%↑
Neutral
33.3%↓
Negative
0.0%
Avg. Target Price
$170.00↑
Maximum Target
$198.00↑
Minimum Target
$136.00
No. of Firms with Target Price/Total
16/21
Risks to the target price include macroeconomic variables and influences, unfavorable weather
conditions, change in the retail calendar leading to difficult comparisons, changing consumer
preferences and merchandising trends, international expansion and product returns. Other risks include
an unfavorable spending environment for consumers, fierce competition, significant exposure to states
with serious housing weakness and a high level of operating leverage that leave the company’s earnings
vulnerable to top-line slowdown.
Recent Events [Note: only highlighted material has been changed]
On Dec 2, 2015, Costco reported better-than-expected comps results for the month of November. The
warehouse retailer recorded flat comps for the month, after a decline of 1% in October and flat comps
registered in September. Comps for November reflect an increase of 3% at the company’s U.S.
locations, offset by a decline of 10% and 3% at its Canadian and international locations, respectively.
On Dec 8, 2015, Costco reported its 1Q16 results, wherein earnings of $1.09 per share decreased 2.7%
from the prior-year quarter and missed the Zacks Consensus Estimate of $1.17. Total revenue, which
includes net sales and membership fee, rose 1.3% to $27,220 million in the reported quarter. Quarterly
net sales inched up 1.3% year over year (y/y) to $26,627 million, whereas membership fee increased
1.9% to $593 million. However, total revenue fell short of the Zacks Consensus Estimate of $27,635
million.
Revenue [Note: only highlighted material has been changed]
The Zacks Digest average total revenue was $27,220 million in 1Q16, up 1.3% y/y. The Zacks Digest
average net sales inched up 1.3% to $26,627 million in 1Q16, while membership fees increased 1.9% to
$593 million.
Per the company, comps for the quarter fell 1%, reflecting a 9% decline in locations at Canada and a 5%
drop at other international outlets, partially offset by a 2% increase at U.S. locations. The company
reported flat comps for November, after a decline of 1% in October and flat comps registered in
September. While lower gasoline prices impacted U.S. comps, currency fluctuations adversely affected
international comps.
Provided below is a summary of total revenue, as compiled by Zacks Digest:
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Revenue ($M)
1Q15A
4Q15A
1Q16A
2Q16E
2015A
2016E
2017E
2018E
Net Sales
Membership
Fees
Total Revenue
$26,284.0
$34,993.0
$26,627.0
$28,315.0
$1,13,666.0
$1,19,857.4↓
$1,30,178.8↓
$1,42,649.0
$582.0
$785.0
$593.0
$599.6
$2,533.0
$2,624.2↓
$2,787.2↓
$2,989.7
$26,866.0
$35,778.0
$27,220.0
$28,914.2
$1,16,199.0
$1,22,485.0↓
$1,32,966.0↓
$1,45,638.7
Digest High
$26,866.0
$35,778.0
$27,220.0
$29,382.0
$1,16,199.0
$1,23,490.0↓
$1,37,801.0↓
$1,51,204.0
Digest Low
$26,866.0
$35,778.0
$27,220.0
$28,401.0
$1,16,199.0
$1,21,575.0↓
$1,28,293.0↓
$1,39,766.0
Y-o-Y Growth
7.4%
0.7%
1.3%
5.3%
3.2%
5.4%↓
8.6%↑
9.5%
Q-o-Q Growth
-24.4%
37.1%
-23.9%
6.2%
Excluding the effect of lower gasoline prices and currency headwinds, the company witnessed comps
growth of 6% during the quarter, with U.S., Canada and other international comps registering an
increase of 6%, 9% and 7%, respectively.
Please refer to the separately published COST spreadsheet for additional details and updated forecasts.
Margins [Note: only highlighted material has been changed]
Provided below is a summary of margins, as compiled by Zacks Digest:
Margins (%)
1Q15A
4Q15A
1Q16A
2Q16E
2015A
2016E
2017E
2018E
Gross Margin
11.0%
11.1%
11.3%
11.1%
11.1%
11.1%
11.2%↑
11.1%
Operating Margin
2.9%
3.2%
2.8%
3.1%
3.1%
3.1%
3.2%
3.3%
Pre-Tax Margin
2.9%
3.2%
2.8%
3.1%
3.1%
3.1%
3.2%
3.3%
Net Margin
1.8%
2.1%
1.8%
2.0%
2.0%
2.0%
2.1%
2.1%
The Zacks Digest average gross profit in 1Q16 was $3,006.0 million, up 3.7% y/y. Gross margin
expanded 30 basis points (bps) y/y to 11.3% in 1Q16.
SG&A expenses were $2,806.0 million in 1Q16, up 4.1% y/y. SG&A expenses, as a percentage of net
sales, were 10.3% during the quarter.
The Digest average operating income dropped 0.2% y/y to $767.0 million during the quarter, with the
operating margin contracting 10 bps to 2.8%.
Please refer to the separately published COST spreadsheet for additional details and updated forecasts.
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Earnings per Share [Note: only highlighted material has been changed]
Provided below is a summary of EPS, as compiled by Zacks Digest:
EPS
1Q15A
4Q15A
1Q16A
2Q16E
2015A
2016E
2017E
2018E
Digest High
$1.10
$1.73
$1.13
$1.31
$5.27
$5.54↓
$6.30↓
$6.97
Digest Low
$1.09
$1.73
$1.09
$1.29
$5.24
$5.48↓
$6.22↓
$6.92
Digest Average
$1.09
$1.73
$1.10
$1.30
$5.26
$5.51↓
$6.27↓
$6.95
13.1%
4.7%↓
13.8%↑
10.8%
Y-o-Y Growth
13.9%
9.7%
0.8%
3.9%
Q-o-Q Growth
-30.7%
48.1%
-36.3%
17.9%
The Zacks Digest average earnings per share rose 0.8% y/y to $1.10 in 1Q16, driven by an increase in
sales, which offset higher operating expenses.
Please refer to the separately published COST spreadsheet for additional details and updated forecasts.
Research Analyst
Harendra Ray
Copy Editor
Oindrila Ghoshal Dutta
Content Ed.
Rajani Lohia
Lead Analyst
Sumit Singh
QCA
No. of brokers
reported/Total brokers
Reason for Update
Sumit Singh
NA
Flash
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