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No. of Recommendations: 1
After going into a Costco Wholesale store for the first time last week, I decided to try and run them
through the Rule Maker Ranker spreadsheet just to see how they would do. Granted, I didn't figure they
would do well at all considering they are a Merchant King in the strongest sense of the word (low margins,
high turnover), and they didn't disappoint. What I found especially interesting was some of the data I
found in their 10-K filing describing their business. For example:

"... Because of its high sales volume and rapid inventory turnover, Costco generally has the
opportunity to receive cash from the sale of a substantial portion of its inventory at mature
warehouse operations before it is required to pay all its merchandise vendors, even though Costco takes
advantage of early payment terms to obtain payment discounts ..."

In this case, it looks like Costco is definitely uses the advantages of a low Flow Ratio to help finance
their business model.

" ... By strictly controlling the entrances and exits of its warehouses and by limiting membership to
selected groups and businesses, Costco has been able to limit inventory losses to less than three-tenths of
one percent of net sales--well below those of typical discount retail operations. Losses associated with
dishonored checks have also been minimal, since individual memberships are generally limited to
members of qualifying groups, and bank information from business members is verified prior to
establishing a check purchase limit. Memberships are invalidated at the point of sale for those members who
have issued dishonored checks to Costco ..."

Here is a case of a company that doesn't exactly "welcome everyone", since their membership
criteria tends to be fairly strict. This approach will sacrifice some sales growth along the way, while
keeping their costs down and their razor thin margins up.

"... Costco's merchandise selection is designed to appeal to both the business and consumer requirements
of its members by offering a wide range of nationally branded and selected private label products, often in
case, carton or multiple-pack quantities, at attractively low prices ..."

Costco recognizes the power of branding, as they only carry a limited selection of goods in their stores.
Many of the items carry their own brand name (Kirkland, if I remember correctly), even though they
may be actually produced by another manufacturer (Whirlpool, for example). By focusing on the brands
people want, they can carry less inventory on hand and improve the overall efficiency of their business.
What they don't do is the other half of the branding equation -- charge a premium for that product because
of the demand.

OK, that's enough of the small talk ... so on with the numbers:

Financial Analysis Company Being Evaluated Competitor #1 Competitor #2 Competitor #3 Competitor #4

Costco Wholesale Wal-Mart Target Kroger <Name>
COST WMT TGT KR <Ticker>
Current PeriodYear-ago PerioYear-over-Year Current Period Current PeriodCurrent PeriodCurrent Period
2000 Q3 2000 Q3 Growth 2000 Q2 2000 Q1 2001 Q1 <qtr>
5/7/00 5/9/99 7/31/00 4/29/00 5/20/00 <date>
Income Statement . . .
Sales 6,894,608 6,053,820 13.9% 46,588,000 7,746,000 14,329,000
Cost of Goods Sold 6,084,246 5,341,716 13.9% 36,044,000 5,203,000 10,502,000
Net Income 120,329 105,877 13.6% 1,596,000 239,000 106,000
Shares Outstanding 478,750 473,570 1.1%

Balance Sheet . . .
Cash & Equivalents 668,340 661,132 1.1% 1,310,000 301,000 163,000
Current Assets 3,447,023 3,081,639 11.9% 25,245,000 6,537,000 5,109,000
Short-term Debt 0 0 No Debt 5,940,000 581,000 570,000
Current Liabilitie 2,961,623 2,662,270 11.2% 26,736,000 5,360,000 5,822,000
Long-term Debt 925,335 912,225 1.4% 16,684,000 5,172,000 7,619,000

Cash Flow Stmt . . .
Cash from Ops 172,494 219,209 -21.3% 1,162,000 (65,000) 1,043,000
Cap. Expenditures 222,799 162,006 37.5% 1,994,000 428,000 455,000

Margins & Ratios . . . 1 1 1 0Competitors' Avera
Gross Margins 11.8% 11.8% 0.0 22.6% 32.8% 26.7% 27.4%
Net Margins 1.7% 1.7% 0.0 3.4% 3.1% 0.7% 2.4%
Cash-to-Debt 0.72 0.72 -0.3% 0.06 0.05 0.02 0.05
Net Cash -256995.0 -251093.0 N/A -21314000.0 -5452000.0 -8026000.0 -11597333.3
Fool Flow Ratio 0.94 0.91 3.2% 1.15 1.30 0.94 1.13
Cash King Margin -0.7% 0.9% -177.2% -1.8% -6.4% 4.1% -1.3%


Continue Here

Ranking Rule Makers

1) Brand Points (0-1) 3) Financial Dire Points (0-3)
Familiarity 0 Sales Growth 2
Openness 0 Gross Margins 2
Optimism 1 Net Margins 2
Legitimacy 1 Shares Outstandin 2
Inevitability 1 Cash-to-Debt 1
Solitariness 0 Fool Flow Ratio 0
Humor 1 Expansion Potenti 2
Subtotal 4 Subtotal 11

2) Financial Locatio Points (0-2) 4) Monopoly Statu Points (0-4)
Mass Market Habit 2 Gross Margins 0
Gross Margins 0 Net Margins 0
Net Margins 0 Net Cash 4
Cash-to-Debt 0 Fool Flow Ratio 2
Fool Flow Ratio 2 Convenience 2
Your Interest 2 Subtotal 8
Subtotal 6
5) Your Enjoymen 1

Total Score 30 Third Tier

Hmmm ... as I said earlier, its miniscule margins don't fare well with our criteria.

To try and get a better feel on how it does in managing its asset turnover, I calculated the Cash
Conversion Cycle for each of the companies in this analysis. This is what I found:

COST COST WMT TGT KR
Q3 '00 Q3 '99
====== ====== ====== ====== ======
DSO 2.2 1.7 2.4 18.3 3.8
DIO 35.0 35.4 52.7 67.6 33.4
DPO 29.7 30.4 31.5 54.6 26.1
====== ====== ====== ====== ======
CCC 7.5 6.7 23.6 31.3 11.1

As you can see, COST does a great job in managing its balance sheet ... especially when compared against it
retailing brethren.

Granted this company is no Rule Maker, but it may very well represent a good blue chip investment to balance
an otherwise volatile technology portfolio.

Just my two cents.

the LanceMan


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