Fitch Downgrades Costco's IDR to 'A+'; Rates Planned Note Issuance; Outlook
CHICAGO -- November 28, 2012
Fitch Ratings has downgraded Costco Wholesale Corporation's (Costco) Issuer
Default Rating (IDR) to 'A+' from 'AA-'. Fitch has also assigned an expected
rating of 'A+' to Costco's planned issuance of $2 billion or more of three,
five and seven-year notes based on market demand. Costco had $1.6 billion of
debt outstanding at Sept. 2, 2012. The Rating Outlook is Stable. A full list
of rating actions is provided at the end of this release.
The rating action follows Costco's announcement that it plans to issue new
senior unsecured debt securities to substantially fund a special dividend of
$7 per share, or around $3 billion. This announcement reflects management's
view that this is an opportunistic time to take advantage of low borrowing
costs in order to pay a larger dividend in advance of higher dividend tax
rates beginning in 2013. Together with its normal dividend, dividends will
total $3.5 billion in the current fiscal year (ending August 2013).
Assuming Costco were to issue up to $3.5 billion of new debt securities,
adjusted leverage would increase from 0.8x at fiscal year-end (August) to 1.7x
on a pro forma basis, and leverage would remain in the mid-1x range over the
next three years. Fitch expects leverage could return to the low 1x range
longer term, as it believes management will not issue additional debt for the
foreseeable future, and that management will utilize free cash flow (FCF) to
repay future debt maturities, the nearest of which will fall in 2016.
The debt issuance notwithstanding, Costco enjoys a strong competitive
position, solid operating performance, and ample FCF and liquidity. Costco's
strong competitive position is supported by its focused merchandising
strategy, with only 3,300 - 3,800 fast-turning products per warehouse and
limited pricing mark-ups, resulting in a loyal customer base and highly
productive warehouses that generate, on average, around $150 million in
High frequency categories account for a significant percentage of sales, with
56% of sales from food and sundries and 18% from ancillary businesses, which
include traffic-drivers such as gas stations and pharmacies.
These factors have enabled Costco to generate solid operating results, with
comparable store sales (excluding fuel and foreign exchange) growing 6% in
fiscal 2012 (ending Sept. 2, 2012) and in fiscal 2011. In addition, membership
renewal rates in the U.S. and Canada have remained high at around 90%.
At the same time, Costco's margins have been steady, with a 3% EBIT margin in
fiscal 2012 and 2011. FCF after dividends was $1.1 billion in fiscal 2012, and
should track around $700 million - $1 billion over the next three years as
capital expenditures move to a range of $1.8 billion - $2 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 grow in the low-to-mid-single-digit range,
and that operating margins will remain within their historical range,
resulting in mid-single digit growth in EBITDA.
Costco repurchased $632 million of its shares in fiscal 2012, and Fitch
expects ongoing share repurchases will be financed with FCF and existing cash,
and will not cause leverage to increase. Costco had cash and short-term
investments of $4.9 billion as of Sept. 2, 2012.
WHAT COULD TRIGGER A RATING ACTION?
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
Fitch has downgraded the following ratings:
Costco Wholesale Corporation
--IDR to 'A+' from 'AA-';
--Senior unsecured notes to 'A+' from 'AA-';
--Convertible subordinated notes to 'A' from 'A+'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'. The ratings
above were solicited by, or on behalf of, the issuer, and therefore, Fitch has
been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology
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Philip M. Zahn, CFA, +1-312-606-2336
70 W. Madison Street
Chicago, IL 60602
Monica Aggarwal, CFA, +1-212-908-0282
Mark Sadeghian, CFA, +1-312-368-2090
Brian Bertsch, New York, +1-212-908-0549
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