Costco Wholesale Corporation: Analytical Essay on Financial Management and Markets

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Costco Wholesale Corporation: Analytical Essay on Financial Management and Markets

Introduction

Costco is among largest wholesale Corporations in the world right after Walmart. It has 760 warehouses, which make it largest wholesale club operator. What make them even larger is the fact that they have wide variety of merchandise and services. Some services include Food Service, Optical, Travel, Auto Program, Photo, even Online Shopping, which makes Costco extremely convenient place for its club members.

As a club-oriented company, Costco has around 100 million members in 11 countries, 44 US states and Puerto Rico. One of the advantages that the members receive is discounts on their merchandise. They sell their products in bulks, so it is very convenient for residential and commercial customers.

Costco follows very simple business strategy in order to provide discounts to its members. They do not carry same or similar items from different manufacturers or brands. They focus on a single brand for particular item/s. This way sales of those particular items increase, which gives them a position to negotiate better deals and prices from the manufacturers. For their high product flow manufacturers are more likely to offer and give good deals. It works in everyone’s favor, consumers, manufacturers and Costco itself.

In, now, distant 1983 the first Costco was open by J. Sinegal and H. Brotman. More precisely it was September 15 1983. It did not take them too long to make it a public company, it happened on December 1 1985.

Due to large membership, Costco’s annual membership fee account for 80 percent of Costco’s gross margin and 70 percent of its operating income. Costco’s membership cost $60 annually for Gold membership and $120 annually for executive plans with extra benefits. Costco has 8% to 10% markup on brand and around 15% on house brand like Kirkland Signature. According to the company’s 2018 results, it sold $138 billion in merchandise. The products they sold cost them $123 billion, leaving $15 billion for the business. All expenses combined totaled nearly $14 billion. Therefore, sales of $138 billion, cost of goods sold of $123 billion, and selling, general, and administrative costs of $14 billion.

Corporate governance

Costco’ model is a big wholesale warehouse business. The corporate governance of Costco has to be associated with the type of business Costco does and its locations in the North America and rest of World. Overall, corporate governance of Costco is doing very good job. However, I believe that there are some problems that could be handled or resolved differently in order to accomplish the healthier results.

CEOs run business, but the board of directors have the ultimate authority.

Whenever they have meetings each board of director need to appear at those meetings. However, if some of them cannot be present at the meeting they must contact a chairman to let them know. I believe that this is how it should be.

The board of directors choose one of the members as the chairman. Although, they can impeach the chairman. Therefore, the chairman does his/her job with constant fear of losing his/her position. This cannot be very productive and proactive. To me this whole practice seems like it is very easy to manipulate and fabricate what one person or group of people wants based on their interests. One person could affect others to make decisions by using their fears. This does not sound like a very healthy environment.

Costco has this policy that director does not receive additional compensation. They get paid for what they do, but no additional salary. I believe that is fair because being a director is already compensated enough.

There is annual meeting with shareholders. This is something that the directors encourage, but not require. If I am a shareholder I would like this meeting to be required in order to learn how the many is handled, unless there are different ways to stay informed.

Lack of meetings and sharing information and ideas is never good. For this reason they should have at least two annual visits.

The bigger family is harder is to manage. So Costco being such a big company their governance could be improved. The global market is changing fast, and businesses need to adapt accordingly. The policies have to be reviewed every year based on location.

SWOT Analysis

Strength: Costco’s biggest strength is in the big packages for less money offered to its customers. This strategy attracts regular people as well as business. They keep prices lover then the direct competitors such as Walmart or Sam’s Club. The better deals bring more memberships, which is their main way of making profit (80% of their profit comes from memberships). Customers find that Costco deals really saves them money, because of this 90% members renew their memberships.

Also, Costco carry very few brands for the same or similar products. This gives them advantage to sell large amounts from the same brand. For this reason Costco is able to get those products for less from its suppliers. Lower cost reflects on lower prices on the product they sell.

Another Costco’s strength is the fact that they minimized their operation cost by using roofs that allow natural light to save on the electric bills. Another way to save money, Costco’s products come in the crates, which are placed on the sales floor. This strategy avoids time spent on stocking the products and hourly wages for stock people. These strategies reduces their costs and allows them to sell for less. Lower prices do not require a lot of advertisement, therefore Costco is not in need of unnecessary fliers and papers.

Huge part of Costco’s strength is their ability to keep their employees. With lower prices and high sales volume they are able to pay their employees more than their competitors. In addition, they offer good benefits and 401 K, which increases the employees loyalty. More experiences work force increase productivity and customer services. Also, reduces the cost of training the new employees.

Weakness: Every business has a weakness so is Costco. Sometimes a strength can be a weakness at the same time. Costco does not carry too many brands for the same product, which plays its advantages as we discussed earlier. However, this can be an disadvantage because sometimes customer wants to have many choices as Costco’s competitors. The same brans could bore customers and push them away for period of time or certain products.

Another point where Costco could improve is the fact that the most of their revenue comes from US and Canada. Therefore, Costco almost entirely depends on to markets, even though there are vastly larger markets in Europe and Asia. If anyone comes in with similar or better business idea Costco would be shaken and forced to change and adapt.

Although, Costco is doing great, they could do even better if they aim at customers from different age groups. Mostly, families and older generation are members, so Costco needs to attract younger populations as well. Younger population tends to spend more money, but they do not need bulks of everything if they live alone or in smaller households. Perhaps, there should be an option to by smaller amount for less price as well.

Opportunity: With the new age and technologies there are always opportunities to make business better. Selling the products online could be one of the things that Costco could make available for its customers. Perhaps this would be one way to attract younger people.

Another way to attract younger groups is to include variety of clothing, technology. Nowadays it is visible that Costco has done something towards that, but younger generations need more. Easier and faster checkouts, such as digital wallets using phones. Being opent to more advanced technologies would appeal younger people who might think that Costco is not cool enough place for them to shop.

As mentioned above, Costco should expand their business outside North American Continent. Imagine amount of revenue if they expend into India and/or China. Those countries have large number of population that are in need of place like this.

Threat: Online shopping is a great opportunity for Costco to improve their business, but it also can be a threat. It would be very difficult to compete with Amazon and/or ebay. Costco would have to spend more resources to become and remain competitive with others.

Costco runs their business on low prices and less costly operation in order to keep slightly higher wages for its employees. However, minimum wages being on the rise could affect Costco’s business model.

Another threat to Costco could be the volume of memberships. Other places also trying to improve their ways of attracting and keeping customers. Costco’s new memberships and renewal memberships could be affected by the Walmart, Target, Sam’s club if they give better customer service and lower prices.

Ratio Analysis

Short Term Solvency: When it comes to solvency Costco has ability to meet their long-term debts and financial obligations. The current, quick and cash ratio went up during the last three years.

Also, current assets increased much above current liabilities. The current ratio has increased due to huge rise in merchandise inventory and cash. Due to incline in cash comparing to increase in current liabilities the cash ratio has gone up during last 3 years. Therefore, meeting the current obligations should not be an issue. However, quick ratio has not change much between 2017 and 2018 as well as account payable.

Likewise, from 2016 to 2017, company has seen greater growth in current liabilities than increase in cash and quick ratio was nearly the same in both years. Therefore they relied too much on the inventory.

In recent years, 2006-2018, the cash has been increased as a result of increase in cash and cash equivalents. However, because of the increase account payable the total liabilities have increased resulting cash ratio not to change. They are not able to pay debts, which results in accounts payable to increase. This trend has been stretched from 2016 until 2018.

Long Term Solvency: Costco’s Total Debt ratio has declined in 2018 and total assets has increased further than increase in total liabilities. They have not paid its long-term debts, which accumulated even more debts in 2019 . Total assets increase comes mostly from the increase in “cash and cash equivalents and increase in inventory. The assets increase comes from the decrease in debt ratio in 2017, which directs that they will be able to meet the long term liquidity. They also have increase in the debt ratio because of increase in long term debts comparable to increase in assets. This happened because they had bought more assets with debt during 2017 then prior year. Based on debt ratio, they would still be alright even if interest rate goes up, of course not too much higher.

If creditors invest more than investors it affects debt equity ratio to increase, and that is what happened with Costco last year. That is not very healthy way to do business.

Total retained earnings have increased in 2018, but not much increase in total liabilities. It is clear that more money is borrowed from banks that creditors because debt-equity ratio is higher. This means larger interest rate. The debt-equity ratio has went up in 2016/17, which might tell us that more money has been loaned from creditors to purchase assets and inventory. This is potential risk to creditors.

Based on equity multiplier being close to 3 during 2018 tells us that asses are manly supported by taking more credit (debt) rather than by its shareholders. So, it make sense that their debt has increased in recent years. Although, the equity multiplies has been slowly decreasing because they are paying of some of the debts. However, in last few years, (2016-2018) they have increased their assets by getting deeper in debt rather than by investors funding. In 2017 Costco has taken a huge loan which greatly affected the equity multiplies (increased).

It is good that their times interest earned ratio in 2018 was 28.17. They were able to meet their obligations due to greater earnings then obligations. As long as they keep earning above interest obligations they are ok.

Assets Utilization Ratio: Since Costco is a warehouse wholesale type of business they depend (current ratio) on their inventory. Last year they had 32 days of day’s sales in inventory. Last couple years their inventory stayed longer. This is probably because of the inventory remained from the previous year (2016-2017) or they calculated that there are going to be more sales so they stocked up.

During 2018 Costco day’s sale in receivable was 4 days. Therefore, they would receive money from their operation within the 4 day of transaction. This stays very similar for them ever since 2016. This is important for the future projection because it mean that their members mostly having a positive credit score.

Because Costco is receiving money from the members in such short time they have not much problem to pay their accounts payable. However, they are still slightly behind. Their days payable outstanding is 33 in 2018. Therefore they are about a month behind, which reflects on payable account to increase in last two years.

Based on total assets turnover (3.4) the total revenue is greater than total assets. Their asset ratio is greater than 1 because they are producing revenue. As long as they keep the asset ratio above 1 that will show efficiency in using assets.

Profitability Ratio: For 2018, profit margin ratio was 0.02 and for 2016 and 2017 only 0.01, therefore profit was 2% and 1% respectively because of increase in total revenue. During this time the cost and net income remained almost unchanged.

According to the return on assets being below one in 2018, we can conclude that they should do a better job converting assets to profit. During this year they purchased more inventory resulting in the assets value to go up. However, the net income stayed nearly the same (did not go up as much) affecting the ratio being below one. Very similar scenario for all three years (2016-2018). They definitely need to do better job converting assets into profit.

The return on equity ratio need to be high in order to show that you are using shareholders money to make money. The higher return on the investment is better for the shareholders. Costco made 24 cents on each dollar in 2018, or the ratio was nearly 24%. Looking at 2017 and 2018 the ratio change is insignificant. In 2018 the net income is higher while equity did not go up much. In 2016 both equity and income were low. Because the income was low the ratio went down.

Market Value Ratio: Price-earnings ratio specifies the probable price of the share based on its earnings. It is a compass for investors to make a decision how much they would pay for the share in future. They want to see this ratio to be high. The market price for the share has increased almost 50% during 2018. Comparing the market prices between 2016-2017 and 2017-2018 we see that there is a great difference. Therefore, the basic price went up, but not share price, which cause the ratio to go down.

References

Costco wholesale, (1998-2019) Investor Relations retrieved November 17, 2019 from https://investor.costco.com/shareholder-services/investor-fags
Iason Dalavagas, (Feb 9, 2015) SWOT Analysis: Costco Wholesale Corporation retrieved November 17, 2019 http://www.valueline.com/Stocks/Highlights/SWOT_Analysis__Costco_Wholesale_Corporation.aspx#.XTTxD4WcHg8
Hitesh Bhasin (Jan 9, 2019) SWOT Analysis of Costco retrieved November 17, 2019 from https://www.marketing91.com/swot-analysis-costco/
Ross, Stephen (2016) Corporate Finance Eleventh Edition. McGraw Hill Education
Steven Nickolas, (Dec 12, 2018) What If You Had Invested Right After Costco’s IPO? November 17, 2019 from https://www.investopedia.com/articles/markets/120115/if-you-had-invested-right-after-costcos-ipo.asp
Daniel Kissinger (Feb 6, 2017) Costco Wholesale SWOT Analysis retrieved November 17, 2019 from http://panmore.com/costco-wholesale-swot-analysis