Analysis of Investing Activities: Costco

Dan Smith

Long Term Assets

Horizontal Analysis

From 2005 to 2006, the land, buildings, and equipment categories all increased an average of 10.3%; however, construction in progress increased by 37.6%. This large increase in construction may be indicative of expansion. Given that the company has experienced revenue growth of 13.6%, 3.3% greater than the average increase in assets, additional expansion may be prudent.

Vertical Analysis

As of 2006, Costco has 15.7% of total long term assets invested in land and 35.7% invested in buildings, leaseholds and land improvement. This discrepancy may be a result of Costco leasing 99 (21.6%) of the properties their stores are located upon, while owning 57 (57.5%) of the building located on leased property.

Costco has a significantly greater percentage of its assets allocated in long-term fixed assets compared to Dick's Sporting Goods. The higher liquidity afforded by Dick's asset allocation may provide greater flexibility; however, having more current assets also carries risks such as time value of money for cash on hand, and obsolesce for inventory. Both strategies are effective; therefore, in this author's opinion, the preferred asset allocation is a matter of investor preference.

Investing Cash Flows

Costco spent 21.8% more cash on investing in new long term assets in 2006 versus 2005. During the same time frame, the company sold 19.0% fewer of their assets. Once again, this may be indicative of expansionary tactics for the company.

Accounting Policies

Costco's acquired assets are recorded at cost with interest incurred during the construction of the asset capitalized within the recorded cost. The assets are depreciated using the strait-line method.

Costco does not hold treasury stock. Any shares repurchased are retired. The Corporation's board has authorized the repurchase of $3 billion worth of common stock over the next three years begining in January 2006. Although the repurcase is contingent on the economic status of the corporation, given the current growth execeding the acquirment of assets, there exist a high probability of the buy-backs occuring. If the buy-back does occur, the market price of the stock may increase due to a higher earnings per share value and a resulting lower PE and PEG.

The company's most recent acquisition was purchasing the remaining 4% interest of CWC Travel Inc. to bring Costco's ownership to 100%. Based upon the current trend of rising travel costs vis-a-vis the rising fuel cost, ownership of a travel company may not be profitable. However, Costco may feel it is buying the company at a discount using the same logic and will expect returns on the investment in later years.

As of September 3, 2006 the company has $71,848 included under "Goodwill." Costco reviews goodwill for impairment on an annul basis; however, no impairment of goodwill has yet to occur.

Property, Plant & Equipment

Depreciation reduced the book value of long term assets by 26.4%. $1,155,406,000 in new assets were added to the books in 2006 while accumulated depreciation increased by $381,303,000. Overall, only a quarter of the total depreciable assets have been expensed, it can therefor be reasoned that the majority of the companies assets are fairly new, implying that Costco is still steadily growing.

Segment Information

Costco operates in five different retail segmentations: Sundries (candy, alcohol, tobacco), Hardlines (appliances, sporting goods), Food, Softlines (apparel, jewerly), Fresh Food, and Ancillary (gas station, food court). The nature of these segmentation allow for the assets attributed to each segment to be presented in a single balance sheet with no differentiation between segments. The percentage of net sales for each segment is as follows: Sundries-24%, Hardlines-20%, Food-19%, Softlines-12%, Fresh Food-11%, Ancillary-14%.

Costco has increased its position in the ancillary segment by three percent over the last two years, from 11% to 14%, possibly as a result of Costco's discount fuel program for members. If this is the cause, Costco should be vigilent in monitoring the emergence of alternative fuels that may reduce the market for unleaded gasoline.

The Company operates across three continents: North America, Europe, and Asia. The majority of assets are held in the United States and Canada, with 80% and 10.9% respectively. All other geographic segmentations represent 9.1% of assets.

Ratio Analysis

Return on Assets- 6.46%
Return on Fixed Assets- 12.9%
Asset turnover - 3.52 (3.42 excluding membership fees)
Fixed Asset Turnover- 7.02 (5.07 excluding membership fees)
Profit Margin- 1.83%