DBRS Assigns Rating of A (high) to Costco, Stable Trend

DBRS has today assigned an Issuer Rating and a Senior Unsecured Debt rating of A (high) and a Short-Term Rating of R-1 (low) to Costco Wholesale Corporation (Costco or the Company), all with Stable trends. The ratings are based on Costco’s large size, efficient operations, strong market position and the benefits associated with its warehouse membership business model, as well as its modest sensitivity to economic cycles. The ratings also consider the high level of competition in the markets Costco serves, risks associated with a more ambitious geographic expansion and the potential for less conservative financial management.

Costco possesses a strong earnings profile that is well placed in the current rating category based on its record of generating consistent and above-industry-average returns on invested capital. Revenues have increased at an average of 10% per year after F2009 to approximately $108 billion in the last 12 months (LTM) ending Q2 F2014. Such revenue growth has been based primarily on strong comparable-store sales growth, averaging 5.5% since F2009, and 3% to 4% of new selling space each year from warehouse openings. Costco strives to drive inventory turnover by maintaining EBITDA margins in the 3.5% to 4.0% range. As such, the Company tends to pass any cost savings or benefits from operating leverage on to customers to build sales volumes. This has contributed to EBITDA growing steadily from $2.5 billion in F2009 to $4.1 billion in the LTM ended Q2 F2014.

Costco is a strong free cash flow generator that has historically maintained a conservative financial profile. Cash flow from operations has grown in line with earnings and has been more than sufficient to finance capital expenditures (capex) and scheduled annual dividends. Between F2009 and F2011, Costco’s cash balance increased from $3.7 billion to $5.6 billion, while balance sheet debt remained steady, near $2.3 billion. In F2012, the Company began to deploy its capital more aggressively, paying $789 million to acquire a 50% interest in its Mexican operation and, two quarters later, paying a $3.0 billion special dividend to shareholders. Costco funded its special dividend with a $3.5 billion debt issue. As such, credit metrics shifted between F2011 and Q2 F2014, with LTM lease-adjusted debt-to-EBITDAR rising from 1.0x to 1.5x and LTM lease-adjusted cash flow-to-total-debt falling from 83% to 53%. At these new levels, metrics are strong for the current rating category.

DBRS expects Costco’s earnings profile to remain stable over the medium term, based on its strong market position in North America and focus on continuous improvement of operational efficiency. DBRS forecasts revenues to increase by 5% to 6% per year and exceed $130 billion per year by F2017 (DBRS’s three-year forecast horizon) based on low-to-mid single-digit comparable-store sales growth and a 4% average annual increase in new selling space, much of which will come from new warehouse openings in international markets. DBRS believes that Costco will maintain EBITDA margins in the 3.5% range, resulting in EBITDA of almost $5.0 billion in F2017.

DBRS expects Costco’s financial profile to remain stable in the medium term. Cash from operations should grow with operating income, while dividend policy remains unchanged and a steady program of new warehouse openings, along with accelerated IT spending requires a capex budget of at least $2.2 billion per year. As such, DBRS forecasts that free cash flow will average approximately $320 million per year through F2017. DBRS expects Costco to use its free cash flow, cash on hand and additional debt to repurchase shares while maintaining lease-adjusted debt-to-EBITDAR below 2.0x, which is appropriate for the current rating category.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodology is Rating Companies in the Merchandising Industry, which can be found on our website under Methodologies.