01—Abstract
Summary
Summary of the 10-K filed October 12, 2016. Cited figures are marked; the original filing is the authoritative source.
Costco's fiscal 2016 10-K (52 weeks ended August 28, 2016) shows a company growing its top line steadily while margin and earnings pressure came mainly from external factors.
Net sales rose 2% to $116.1 billiona, but comparable sales were flat, as gasoline price deflation (about 193 basis points of drag) and unfavorable foreign currency movements (about 237 basis points) offset growth from new warehouses. Membership fee revenue grew 4% to $2.6 billion, supported by a 47.6 million paid member base and a 39% Executive member mix, though the worldwide renewal rate eased to 88%. Net income attributable to Costco fell 1% to $2.35 billion, or $5.33 per diluted share, versus $5.37 in 2015, which included a one-time tax benefit.
Underlying profitability improved on a reported basis. Gross margin rose 26 basis points to 11.35% of net sales, largely because gasoline deflation lowered sales denominators, while SG&A rose 33 basis points to 10.40%, partly from investments in information systems modernization. Operating income grew about 1% to $3.67 billionb.
Cash flow was softer: operating cash flow fell to $3.29 billionc from $4.29 billion, mainly because of roughly $1.7 billion in vendor payments accelerated into the last week of fiscal 2016 ahead of a new accounting system rollout. Capital spending of $2.65 billion, 29 net new warehouses, and a dividend increase to $0.45 quarterly were the main capital allocation actions. Management plans up to 31 openings and $2.6 to $2.8 billion of capex in 2017.
The filing also flags concentration and legal risks. The U.S. and Canada generated 87%d of net sales and 84% of operating income, and California alone accounted for 31% of U.S. net sales. International operations (27% of sales, 39% of operating income) carry currency exposure.
Disclosed legal matters include a DEA inquiry into controlled-substance prescription fulfillment, unclaimed property examinations, and motor fuel temperature litigation. Management does not believe these will have a material adverse effect on financial position, though an individual quarter could be affected.
02—Key points
Key Highlights
- Net sales rose 2% to $116.1 billion, but comparable sales were flat (U.S. +1%, Canada -3%, Other International -3%). Currency and gasoline price declines were the main drags.
- Membership fees rose 4% to $2.65 billion, with 47.6 million paid members (up from 44.6 million) and 39% of paid cardholders on the higher-fee Executive tier. Worldwide renewal fell to 88%, and 90% in the U.S. and Canada.
- Gross margin improved 26 basis points to 11.35%, largely from gasoline price deflation. Excluding that effect, gross margin rose 5 basis points to 11.14%. SG&A rose to 10.40% of sales, driven by systems modernization spending.
- Diluted EPS was $5.33, down from $5.37 in fiscal 2015, which benefited from a $57 million tax benefit tied to the special dividend. Operating income grew about 1% to $3.67 billion.
- Operating cash flow fell to $3.29 billion from $4.29 billion because about $1.7 billion of vendor payments were accelerated into the final week of the fiscal year, ahead of a new accounting system. Cash and short-term investments declined to $4.73 billion.
- The quarterly dividend was raised from $0.40 to $0.45 per share. The $4.0 billion buyback authorization had $3.22 billion remaining, and 3.18 million shares were repurchased in fiscal 2016.
- Expansion continued with 29 net new warehouses (715 total at year-end), and fiscal 2017 plans call for up to 31 openings and capex of $2.6 to $2.8 billion. Costco also transitioned to a Citi-Visa co-branded card program in June 2016.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2016, Costco Wholesale Corp kept $0.02.
- Revenue$118.72B100.0%
- Cost of revenue−$102.90B86.7%
- Gross profit$15.82B13.3%
- Operating costs−$12.15B10.2%
- Operating income$3.67B3.1%
- Interest, other & tax−$1.32B1.1%
- Net income$2.35B2.0%
Where FY2016 revenue went
$118.72B- Cost of revenue: $102.90B, 87% of revenue
- Net income: $2.35B, 2.0% of revenue
- SG&A: $12.07B, 10% of revenue
- Interest, other & tax: $1.32B, 1.1% of revenue
Kept 2.0% as net incomeNet income $2.35B · 2.0%Interest, other & tax $1.32B · 1.1%
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2016filed October 12, 2016Financial Statements
FY2016 against FY2015
| Line item | FY2016FY2015 | Change |
|---|---|---|
| Revenue | $118.72B$116.20B | +2.2% |
| Cost of Revenue | $102.90B$101.06B | +1.8% |
| Gross Profit | $15.82B$15.13B | +4.5% |
| SG&A Expenses | $12.07B$11.45B | +5.4% |
| Operating Income | $3.67B$3.62B | +1.3% |
| Interest Expense | $133.00M$124.00M | +7.3% |
| Net Income | $2.35B$2.38B | −1.1% |
| EPS (Basic) | $5.36$5.41 | −0.9% |
| EPS (Diluted) | $5.33$5.37 | −0.7% |
| Shares Outstanding (Basic) | 438.58M439.45M | −0.2% |
| Shares Outstanding (Diluted) | 441.26M442.72M | −0.3% |
05—Questions
Frequently Asked Questions
Why did Costco's net income decline in fiscal 2016 even though sales and operating income grew?
Net income attributable to Costco fell 1% to $2.35 billion from $2.38 billion. Fiscal 2015 benefited from a $57 million one-time tax benefit tied to the special dividend paid through the 401(k) plan, and interest income declined. Operating income rose about 1% to $3.67 billion, and the effective tax rate increased to 34.3% from 33.2%. Foreign currency headwinds reduced diluted EPS by about $0.24.
Why did comparable sales stall at zero growth, and what does that mean for the investment case?
Comparable sales were flat, with U.S. up 1%, Canada down 3%, and Other International down 3%. Excluding foreign currency and gasoline price effects, total comparable sales grew 4%, which suggests underlying demand remained healthy. Gasoline deflation (a 19% drop in average price per gallon) and a stronger U.S. dollar accounted for most of the reported weakness. Investors should watch whether the underlying 4% growth can persist as currency and fuel effects fade.
Is the company's cash flow weakening, and is the drop in operating cash flow a concern?
Operating cash flow fell to $3.29 billion from $4.29 billion, but the main cause was timing. Roughly $1.7 billion of vendor payments were made in the final week of fiscal 2016 ahead of a new accounting system going live. Accounts payable fell $1.5 billion as a result. Investors should confirm this reverses in fiscal 2017 operating cash flow, since the company's model depends on paying suppliers after selling inventory.
How concentrated is the business geographically, and what are the main risks?
The U.S. and Canada generated 87% of net sales and 84% of operating income in 2016, and California accounted for 31% of U.S. net sales. This concentration means a slowdown in California or Canada would have an outsized effect. International operations contributed 27% of net sales and 39% of operating income and are exposed to currency movements, which hurt results in 2016. Other risks include reliance on membership renewals, pressure from competitors such as Walmart, Amazon, and Sam's Club, and ongoing legal matters including a DEA investigation into prescription fulfillment.
What is the capital return and growth outlook?
Costco raised its quarterly dividend 12.5% to $0.45 per share and had $3.22 billion remaining under its $4.0 billion buyback authorization, which runs through April 2019. Fiscal 2016 capex was $2.65 billion, and the company expects $2.6 to $2.8 billion in fiscal 2017 with up to 31 new warehouses. Management said these investments will be funded from operating cash flow and existing cash, with no new financing expected. Continued SG&A pressure from information systems modernization is expected to persist.
06—Continue