Fitch Ratings affirms Costco's Issuer Default Rating at A+, with stable outlook, reflecting retailer's strong competitive position, solid operating performance, ample free cash flow and liquidity

Cindy Allen

Cindy Allen

Nov 20, 2013 – Business Wire

CHICAGO , November 20, 2013 (press release) – Fitch Ratings has affirmed Costco Wholesale Corporation's (Costco) Issuer Default Rating (IDR) at 'A+'. Costco had $5.2 billion of debt outstanding at Sept. 1, 2013. The Rating Outlook is Stable. A full list of rating actions follows at the end of this press release.

KEY RATING DRIVERS

The affirmation reflects Costco's strong competitive position, solid operating performance, and ample free cash flow and liquidity. Costco benefits from a focused merchandising strategy, with only 3,700 fast-turning products per warehouse and limited pricing mark-ups, resulting in a loyal customer base and highly productive warehouses that generate, on average, more than $160 million in revenues annually. High frequency categories account for a significant percentage of sales, with 56% of sales from food and sundries and 17% from ancillary businesses, which include traffic-drivers such as gas stations and pharmacies.

These factors have enabled Costco to maintain strong comparable store sales growth (excluding fuel and forex) of 6% each of the past three fiscal years (ending August). In addition, membership renewal rates in the U.S and Canada have remained high at around 90%.

Costco's margins have been steady, with a 3.2% EBIT margin in fiscal 2013 (ended August), up from 3.0% in fiscal 2012 and 2011. Free cash flow after regular dividends was $843 million in fiscal 2013, but was negative $2.2 billion after the payment of a $3 billion special dividend. FCF is expected to track between $700 million - $1 billion over the next three years as capital expenditures move to a range of $2.3 billion - $2.5 billion, from $1.5 billion in fiscal 2012, to support a faster pace of new store growth.

Looking ahead, Fitch expects comparable store sales (excluding fuel and foreign exchange) will continue to continue to grow in the low-to-mid-single-digit range, and that operating profitability will remain within its historical range.

Costco issued $3.5 billion of 3, 5 and 7 year notes in December 2012, with the proceeds used to pay a special dividend of $7 per share, or $3 billion. Together with its normal dividend, dividends totalled $3.5 during fiscal 2013. The effect of the note issuance was to increase adjusted leverage from 0.8x at fiscal year-end 2012 to 1.6x at fiscal year-end 2013. Looking ahead, leverage is expected to remain in the mid-1x range over the next two years, showing gradual improvement on EBITDA growth. Leverage could decline to the low-1x range in fiscal 2016 should the company repay with cash a $1.2 billion note maturity.

Costco repurchased only $36 million of its shares in fiscal 2013, following $632 million of repurchases in fiscal 2012. Fitch expects ongoing share repurchases will be financed with free cash flow and existing cash.

Costco's liquidity is solid. The company has maintained significant cash and short-term investment balances ($6.1 billion at Sept. 1, 2013). The company does not have a committed U.S. bank facility as it does not need to access the CP market and can fund working capital internally.

RATING SENSETIVITIES

Positive: Continued strong operating momentum combined with a sustained reduction in lease-adjusted leverage to the low-1x area could lead to a positive rating action.

Negative: Additional shareholder-friendly actions that push adjusted leverage to the high-1x range for an extended period could lead to a negative rating action.

Fitch has affirmed the following ratings:

Costco Wholesale Corporation

--IDR at 'A+';

--Senior unsecured notes at 'A+';

The Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 5, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Effective from 8 August 2012 - 5 August 2013

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=808531

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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