The estimated reading time for this post is 10 Minutes

Introduction

Costco Company is a wholesale corporation that runs an international chain of membership warehouses, designed to help the small and medium sized businesses to reduce costs in purchasing for resale. Apart from reducing costs, these warehouses present one of the largest exclusive product category selections under one roof. Costco is known for profit making, and has grown from a zero to nearly over a three billion-dollar seller in less than six years span. The secret behind its success is its strategy of selling products at low prices but at high volumes. This paper analyses Costco annual reports for the year ended August 31, 2010 and gives reasons why an investor should make this firm his choice.

Summary of the CEO letter to shareholders

In this letter, the top officials are very optimistic about the year 2010, having been disappointed by the past two years. Though the year 2010 was characterized by fragile economic conditions in most of their markets, the year produced a record in terms of sales and earnings. This record sale is seen by Costco’s achievement of $7.63 billion sales in 2010 up from $69.9 billion sales in 2009, a net earning of $1.3 billion, and an eighteen percent increase in earning per share.

Despite the uncertainty in the economy in 2010, members who shopped in the Costco warehouses increased by four percent spending three percent more than they did in 2009. Most of the members shop in their fifty-six stores, which recorded over two hundred million dollars in sales in 2010 with two of them giving more than three hundred million dollars. In terms of expenditures, the letter estimates Costco’s costs to be nearly one billion dollars on capital expenditures. This big capital expenditure is justified in Costco’s plan to open nearly five hundred and eighty two warehouses in operation around the world to meet the increasing strong demand.

Costco management is among the most experience in warehouse retail business, as they compose of people who have worked with the company for a number of years. This experience makes them at a proper position to accomplish the firm’s objectives. This pool of professionals enables Costco to remain a dominant warehouse club operator with over six hundred million loyal members and ninety percent of them renewing their membership annually. The renewal has enabled Costco raise nearly $1.7 billion in renewal fees.

The CEO affirms that Costco continuously adjusts its product mix to meet the various needs of the unique customers they continue to serve. This adjustment is achieved partly by their efficient merchant and operator services that facilitate efficient sourcing, shipping and selling of their quality goods and services. Apart from these, their sales have been increased by the e-commerce business option which realized two billion dollars in sales.

The top officials promised to work harder to keep up the pace of success, with a major focus on expanding operations, increasing sales, reducing costs and maintaining a market leadership in the industry as they continue to reward their shareholders. They promise to achieve this by concentrating on their mission of continually offering quality goods and services to their members and employees.

In my opinion Costco is a performing company that does not only promise quality, but delivers it. This has made it gain a remarkable level of trust among its consumers. If they continue with at the same pace they are in, I believe their expansions plans will come to pass and soon they will be a monopoly in the industry.

The general business sections

The major topics discussed in this area address the activities, events, conditions and developments that Costco anticipate may occur in the near future.

Sales and inventory

Costco offers their customers and member customer a variety of goods at low prices. To achieve this effectively, they purchase a large quantity of goods directly from the manufacturers and store them in their warehouses. This bulk supply and sales of goods gives them high sales volume, which is a major reason for their high profits.

Membership policy

This is carried out by the firm, to capture a large number of loyal customers and ensure a constant source of revenue from membership renewals.

Competition

The industry is highly competitive having nearly eight hundred warehouse clubs all over North America. Despite this wide range of warehouse all over the country, it still faces competition from supermarkets and other stores scattered all over the country.

Costco SWOT analysis

The SWOT analysis describes the strengths that a firm possesses, the weaknesses it has, opportunities it can take advantage of, and the threats that the industry posses. This section analyses Costco’s strengths, weaknesses, opportunities, and strengths.

Strengths

Costco has a good record of success in sales which is a major strength. The sales have been increasing by 9.1 % from 2009 driven primarily by a seven percent increase in comparable sales. This increased sale is attributed to Costco’s culture of offering goods and services at cheaper prices and in bulk quantities, and the increased number warehouses. The increase in price of gasoline and the strengthening of certain foreign currency exchange rates are also a major strength. Costco’s major strength is the opening up of more warehouses all over America and in the international market as well. This has increased their sales, as it has increased their customer base.

The membership program is a major strength for Costco to take advantage of. This program has enabled Costco raise millions in revenues from membership fees which has increased from 10.3% in 2009 and keeps on rising annually by eight percent in form of new membership. Membership renewal rates at eighty eight percent in the United States and Canada.

Weaknesses

Despite its strengths, in sales volumes and membership numbers, Costco has some areas in which it needs improvements for better performance. It is in these areas that it is more venerable to attacks by competitors. First among them is their lack of cost control. Despite their significant level of cost control, they have not fully mastered the control of all costs, as some expenses like healthcare expenses are completely outside their control. Secondly, their goal of minimizing costs which extends to reducing wages and benefits of employees can impact them negatively as they can lose their employees to their competitors in the industry. Lastly, operating on very low margins has some substantial impacts on net income primarily due to higher employee benefit costs especially employee healthcare and compensation.

Opportunities

Costco Company still has some growth potentials that can improve its sales and profits. Increasing the number of warehouses in both America and Canada and expanding into other countries can boost it s income potential. This will provide them with a wide market area and enable them benefit from economies of large scale. Secondly, the ever increasing prices of gasoline pose a good opportunity for growth. Costco can increase their gasoline products to capture this market. Thirdly, they can also venture into more product lines like stationery and construction equipments to increase sales and also offer services like whole family recreation facilities, foods and restaurants among others.

The membership program is a good opportunity which can be fully exploited by introduction of other membership lines like junior membership for the young, teen membership for the teenagers and maybe achievers membership for the young adults. Apart from this they can develop more superior brands and enhance customer loyalty.

Threats

Costco though strife for success is marred by forces beyond their ability that pose as major threats to the firm. Among these threats are the fluctuations in currency exchange rates, changes in the cost of gasoline, and the surrounding competitive conditions. The fluctuating currency exchange rates greatly affect comparable sales rates in the industry, since a weak currency leads to low comparable sales volume. The economic conditions in which the business is carried out also affects the business. Adverse economic conditions negatively impact spending by consumers and can lead to low sales growth and sales margins. Another threat is the vigorous and widespread competition from other warehouse clubs, supermarkets and internet retailers which tends to minimize sales. The last and more severe weakness is product cannibalism, where their old warehouses loose the market to the newly established ones.

Financial analysis

The income statement

Revenues

The revenues for the past three years have been increasing anomalously having dropped slightly in 2009. Total revenues at end of fiscal year 2008 were $72,483, $ 71,422 in 2009, and $ 77,946 in 2010 giving us a rate of -1.4 percent in 2009 and 8.37 percent the following year.

Gross margin percentage

The gross margin for the three years is $7,474 in 2008, $7,554 in 2009 and $ 8,260 in 2010. The gross margin percentage for 2008 is 10.31%, for 2009 is 10.57%, for 2010 is 10.59%. This margin is increasing as a percentage.

Operating profit

The selling, general and administrative expenses for the three years; 2008, 2009, 2010 years are $ 6,954, $ 7,252, $ 7,840 respectively and the operating profits are $65,529, $64,170, and $70,106 respectively. The operating profit increases across the three years.

Total income

Total income for 2008, 2009 and 2010 is given by the operating profit less interest, tax and miscellaneous expense. Total income for the three years will be $64,653, $63,393, and $69,238 respectively. The total income is increasing and this can be attributed to the increased sales volumes and reduced expenses across the three years.

The Balance Sheet

Current ratio

Current ratio calculations are given by a division between current assets and current liabilities. The current ratio for 2009 and 2010 are 1.1137 and 1.1634 respectively. The ratio has gone up by 0.0497.

Total inventory to total assets

Total assets for years 2009 and 2010 are $ 21,979 and $ 23,815 respectively with the inventories being $ 5,405 and $ 5,638 respectively. The total inventory as a percentage of total asset will be 24.59% f0r 2009 and 23.67% for 2010.

Total equity to total assets

Total equity for 2009 and 2010 are $10104 and 10930 respectively giving us a total equity/total assets ratio of 45.97% and 45.89% for 2009 and 2010 respectively. These values show the percentage of the assets controlled by the shareholders the remaining 54.03% and 54.11% represent the owner’s portion respectively for the two years. This number has changed slightly with shareholders losing on their ownership percentage.

Cash flow statement

Cash proceeds that have been received from the operating activities are $2,206, $2,092, and $2,780 for the years 2008, 2009 and 2010 respectively. The investment category spent $1,717, $ 1,101; $ 2,015 for the years 2008, 2009, and 2010 respectively, while the financing sector consumed $643, $439, $719 for the three years respectively.

The cash from operating activities seems to be increasing from $2,206 in 2008, $2,092 in 2009, and finally to $2,780 in 2010. In comparison with operating income for the 2008, 2009 and 2010 which is $1,283, $1,086, and $1,303 respectively, the operating income appears greater than the operating income.

Footnotes

This section mainly covers the major accounting maters that were presented in the financial report. These accounting policies discussed in this section include the use of estimates, reclassifications, basis of presentation, cash and cash equivalents, statement at cost of property and equipment, impairment of long-live assets, and revenue recognition.

Current events

Costco’s plan of expansion has been faced with challenges more so its plan to open four more pumps in its popular gas bar at Scarborough (Hutch 4). Crisco had desired to expand the number of its pumps from twelve to sixteen at this gas bar, which upon its opening created chronic lineups of drivers on local streets and raised neighbors’ hackles. Since Costco offered its products at a cheaper price some drivers could come all the way from Witby to get the ten percent discount on every liter (Hutch 4). This expansions planned were barred by the by laws set in place which required the creation of more space around the gas bar for lineups on the company property and not on local roadways.

The effect of this on business is the processing capacity of the gas bar will decline and more customers will be lost out of the frustrations they will face by waiting for long hours in the queues. Costco will also be faced with the problem of negative publicity, and the competitors may brand it as seeking to achieve high profits at expense of public welfare. This will consequently affect profits and sales negatively.

Audit report

Costco Company financial records were audited by KPMG, who further gave recommendations for improvements in accordance to the auditing requirements. In my opinion they presented a clean report following the required auditing standards and abiding by the standards set by the Public Company Oversight Board.

In conclusion, if I had a chance to invest in any company, I will choose Costco. With this firm I will have the assurance that my shares will yield good returns due to increasing sales and profits they are experiencing, offered by their large customer base both locally and internationally.

Works Cited

Hauch, Valerie. “Costco Loses Bid to Expand Scarborough Gas Bar” The Star 2011. 4-5. Print.

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