Costco is a wholesale clubs that operated a chain of warehouses that sold food and general merchandise at large discounts

to member customers. Its closest competitors are SAMs Club and BJs Wholesale. Costco win the competition by targeting a wealthier clientele of small business owners and middle class shoppers. There are several strategies that used to make differentiation: a) Segmented target market: Wealthier clientele of small business owners and middle class shoppers b) Low price sell: margin not more than 14% c) Sell product in bulk package d) Implement just in-time process in order to reduce inventory cost Costco wholesale went public in November 1985 at a price of $ 10 per share and when it happened, the company has 15 warehouses in operation. Margarita Torres, one of Costcos member purchased shares in Costco Wholesale Corporation because she impressed by the companys low prices and the local warehouse is always crowded. After the analysis to the Costcos financial performance for the previous 5 years, Torres concluded that the company had grown at a manageable rate using internally generated funds rather than debt or equity to finance expansion. Although the company suffers from the rapid introduction of stores, the financial ratios indicated that it not impact on the operational efficiency (asset and inventory turnover steady also gross and operating margins remained healthy). There are 2 components in judging the value of stock holding, which is : a. The future performance of the business b. The potential for continued returns from the current price levels Torres evaluate her investment in 2 steps, which are : 1. Forecast the companys operations several years out to understand what the business would look in terms of number of stores, sales per store, and profitability. 2. Value the business using a discounted cash flow model to get a better understanding of what rate of future return she should expect, given the current stock price The process of forecasting is relied on the information from the industry reports which compiled by Standard and Poors, research analyst reports, web casts with company management archived on the investor relations section of company websites, and business periodicals. There are 4 steps in determining a financial forecast, which are : a. Listing the fundamental factors that would drive growth, which are : 1. Number of warehouses that the company would operate in the U.S 2. Sales per store ($100 million) 3. Membership base 4. Operating margins 5. International expansion b. Forecasting Costcos income statement and computing a rough estimate of free cash flow based on the determination in step a. In doing this, Torres do :

1. Forecasting the financial statement using 2010 as a terminal year, that include : a) Merchandise Sales Assuming the number of U.S. stores, the number of international stores, and sales per store. The output is merchandise sales. b) Membership Revenue Assuming the members per store and the revenue booked per member. The output is the membership revenue. c) Operating Ratios Assuming the cost of goods sold as a percent of merchandise sales, SG&A as a percent of merchandise sales, pre-opening expense per stores, and interest expense. The output is income statement line items. 2. Projecting the year-end balance sheet amounts a) Net Operating Working Capital Assuming net working capital required per store. The output is net operating working capital. b) Net Operating Long-Term Assets Assuming net PP&A required per store, other long-term assets required per store, non-interest bearing long-term liabilities. The output is net operating long-term assets. c) Invested Capital Assuming long-term debt. The output is shareholders equity and free cash flow. c. Running a quantitative check on the numbers, comparing key ratios to the historical results to consider the feasibility of the projections. The quantitative checks included : - Sales growth of 10% to 12% - Earnings growth of 16% - Earnings per share growth of 15% - Member count as a percent of the U.S. population - Sales per member - Return on equity d. Running a qualitative check on the numbers to understand whether the projections were conservative or aggressive.

Study Questions : 1. How appropriate are the five factors that Torres chooses to determine the future performance of Costco? The factors are number of warehouses, sales per store, membership base, operating margins, and international expansion. Those factors are quite appropriate, except for the 1 st (action of warehousing is too assertive) and 3rd factors, because the renewal rate is constants.

2. What other relevant factors might be included in a forecast of the business? To what extent are they covered in the factors above? Other factor is how to increase ROE. Based on articles Torres does not make forecasting on how to increase turnover asset. Even the sales is increase steadily 8%-9% but the numbers of total asset is also increase around 8%-9% means that the ration of turnover asset is stable. 3. Review Torres assumptions in Exhibit 2. Which assumptions would represent a change from Costcos historical performance? Do you feel her assumptions are appropriate, and if not, which ones would you change? We think that it is not appropriate, because the assumption of cost of goods sold is to perfect and the reality is that the COGS are depend on a lot of outside factors like the condition if the market itself. There is also missed-prediction in the numbers of membership. Torres predicts that the number would be 10% from population (500.000), but Costco got only 34.100 in the end of 2010. And the members per store are not chance, steady in 50 members per store. Also Torres did not consider the competition effect; the saturation point in the US market was 1500 warehouses shared among all competitors. 4. Review Torres forecasted income statement and common-size income statement. Do you feel these are achievable results for Costco? Based on answer no 3, I think the forecasted income statement is not achievable. 5. Review Torres forecast in Exhibit 5. How does the rate of expansion (i.e. new store openings) affect the balance sheet and free cash flow? Do you agree with her terminal value assumptions? Effect on the balance sheet: the assets grow very rapidly. Effect on the free cash flow: there will be much cash outflow, so perhaps Costco will experience some problem with liquidity. 6. How does Costcos use of the equity method to account for its ownership of the 20 warehouses in Mexico effect the income statement forecast, the balance sheet forecast, and the discounted cash flow model? The ownership are in assumption as additional cost for the equity of Costco. 7. Review Torres quantitative checks. Compare her projections with managements forwardlooking comments. Based on these and other constraints (e.g. the effect of competition, historical performance, etc.) do you feel that her forecast is realistic, conservative, or aggressive? What does the theory of reservation to the mean say about Torress projections? Which do you agree with? Her forecast was aggressive 8. Would you recommend that Torres buy, hold, or sell her Costcos shares at the price of $35? We think that Torres should buy more shares of Costco, because based on her forecasting, it will increase more.

COSTCO WHOLESALE CORPORATION FINANCIAL STATEMENT ANALYSIS (B)

SUMMARY

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Andi Wahyudi (29110045) Christine Hermawan (29110053) Hadi Mukhaiyar (29110054) Faiz. M. Zen (29110057) David Tarigan (29110058) Agia Ferdian (29110070)