CASE: A-186A DATE: 06/19/03

Brian Tayan prepared this case under the supervision of Professor Maureen McNichols as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.

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COSTCO WHOLESALE CORPORATION FINANCIAL STATEMENT ANALYSIS (A)

INTRODUCTION

Margarita Torres first purchased shares in Costco Wholesale Corporation in 1997 as part of her personal investment portfolio. Between 1997 and 2002, she added slightly to her holdings from time to time when the company sold stock for what she felt was a reasonable valuation, and up to that time she did not sell any of her shares. Having watched Costco grow from 265 warehouses to 365 worldwide, and from sales revenue of $21.8 billion to $34.1 billion, she wondered what factors led to such successful growth. She also wanted to determine whether those factors would hold consistent going forward.

At this point, Costco was one of a special breed of retailers called wholesale clubs. Unlike other retailers, wholesale clubs required that customers purchase annual memberships in order to shop at their stores. Costco operated a chain of warehouses that sold food and general merchandise at large discounts to member customers. The company was able to maintain low margins by selling items in bulk, keeping operating expenses to a minimum, and turning inventory over rapidly. Costco’s closest competitors were SAM’S Club (a division of Wal-Mart) and BJ’s Wholesale, which both operated as wholesale clubs. Other competitors included general discounters (such as Wal-Mart), general retailers (such as Sears), grocery store chains (such as Safeway), and specialty discounters (such as Best Buy).

Torres first considered investing in Costco because she herself was a member. She was impressed by the company’s low prices and noticed in particular that her local Costco was always crowded. She decided to research the company and started, as always, with their annual reports. She discovered a company with tremendous growth potential, strong operational efficiency, and a dedicated management team – and a stock selling at a reasonable price. Now, in July 2002, having profited well from her investment, she decided it was time to update her analysis and determine whether the company was still operating efficiently.

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This document is authorized for use only by Shah Hussain Adib in Finance, Economics & Decision Making Fall21 taught by BULENT AYBAR, Harvard Continuing Education from Sep 2021 to Feb 2022.

Costco Wholesale Corp.: Financial Statement Analysis (A) A-186A p. 2

INDUSTRY OVERVIEW – RETAIL

Department Stores

The retail industry in the United States was transformed in the late 1800s by the rise of department stores and general merchants. Companies such as R.H. Macy & Company (founded in 1858) and Bloomingdale Brothers, Inc. (1872) opened stores in New York City and subsequently began to expand across the country. Department stores became famous not only as places to shop, but also as destinations for the new pastime of window-shopping. These stores revolutionized retailing by offering a variety of products in one location and by developing a reputation for excellent customer service. Other innovations included free delivery of purchases and the ability for customers to make purchases using store credit.

The most dominant department store for most of the 20th century was Sears, Roebuck and Company. Founded in 1893 as a mail-order company, Sears opened its first retail store in 1925. By 1945, Sears achieved $1 billion in sales. Throughout the 1950s and 1960s, the company expanded aggressively across the country, selling everything from clothing to appliances to televisions and home repair items. Trying to find success in ventures beyond retailing, the company had owned at one point Allstate Insurance (home, life and auto insurance), Coldwell Banker (real estate broker), and Dean Witter Reynolds (stock brokerage). Sears also launched the Discover credit card. From the mid-1970s through 2002, however, the company struggled, and all of these companies were being sold off. In 2001, Sears had sales of $41 billion and Federated Department Stores, which owns Macy’s and Bloomingdales, had sales of $16 billion.1

Discount Stores

The 1960s witnessed a new breed of retailer, the mass discounter. These companies originally targeted lower income consumers with a broad product line similar to that of Sears and other department stores. Discounters, however, differentiated themselves by de-emphasizing the shopping experience and instead focused on delivering items at the lowest price. In 1960, discounters had combined sales of $2 billion. Over the next four decades, discounters prospered.

In mid-2002, the largest discounter was Wal-Mart, founded by Sam Walton. Walton started his career as a management trainee at J.C. Penney and later as a franchiser of five-and-dime stores. In 1962, he opened the first Wal-Mart store in Rogers, Arkansas. The operating philosophy of Wal-Mart was simple: offer products to customers at the lowest price possible, locate stores in rural locations, where they can serve the average A

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