Costco Case Analysis

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Leverage

The decreasing financial leverage indicates a lesser portion of Costco’s total assets is attributed to debt. This drop in financial leverage also leads to the decrease in ROE. The stable ROA (around 8.2%) tells investors that Costco maintains its ability in converting its assets to net income. However, the sharp drop in ROA in 2001 is a red flag to investors.

Turnover and margins

The 0.4 drop in asset turnover indicates Costco is using its assets to generate revenue less efficiently. With an increased asset base from warehouse expansion, Costco’s net sales and return on sales (from 1.43% to 1.73%) both increased from 1998 to 2001.

Pretax income and tax effect

The increasing pretax income and stable tax effect (60%) helps investors determine that the changes in net margin is driven by operating efficiencies instead of the ability of Costco management to influence its tax rate.

Benchmarking Ratios

In order to understand how Costco performs in operating efficiency, we can compare Costco’s ratios with its key competitors Sears, Wal-Mart, and BJ’s Wholesale of year 2001. Compared to its competitors, Costco has stronger sales and discounts, lower profitability, and weaker short-term liquidity.

Of the four major retail players, Costco ranks the 3rd in terms of net margin and the 4th in operating margin. This indicates that Costco is less profitable than Sears and Walmart from selling goods after paying all operating expenses and the least profitable after paying all expenses. While Wal-mart ranks 1st in operating margin and net margin, showing a strong profitability.

In addition, Costco doesn’t have a good short-term liquidity compared to its key competitors because it ranks the 4th in current ratio. The highest inventory turnover reflects that a strong sales and strong discounts. Costco maintains a similar accounts receivable and accounts payable period with its key competitor Sears and Wal-mart.

Conclusion/Recommendation

As a major wholesale corporation in the United States, Costco is growing at a sustainable rate from 1998 to 2000. In this time period, Costco’s operating income and net income have fluctuated but showed a growth trend in profitability. The growing profitability is due to the fact 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. Due to the sustainable growth from 1998 to 2000, Margarita Torres should hold the shares she has invested in Costco. Meantime, she should monitor Costco’s financial performance in the following two to three years and decrease her shares if the decrease in profitability continues. Furthermore, Margarita Torres can consider purchasing Wal-mart stocks because Wal-mart is also a competitive retail player with a strong profitability.