Financial Analysis of Costco, Wal-Mart and BJ’s Warehouse Club

1. Introduction
This paper seeks to evaluate three companies in the same industry, and make an investment recommendation on which one of them is the best to invest with. The companies to be studied are Costco, Wal-Mart, BJ’s Wholesale Club (or BJ). This paper will include an analysis of the retail industry and the companies’ financial statements which include their balance sheet, income statement and the cash flow statements for the last four to five years for the purpose making a proper comparison of each company. From the analysis financial of the statements, financial rational ratios of each will be extracted to facilitate the evaluation of the companies in relation to industry averages.

      This will also attempt to determine whether the companies’ revenues are tied to one key customer and whether such revenues are tied to one key product including the extent of such, if there is any proof. . Other issues to be addressed include determining the extent of companies’ reliance to single supplier, whether the companies’ revenues are generated overseas, the extent of such generation, if such was a fact and the degree of competition that is happening within the players in the industry.  This will further discuss the company’s future prospects as well as the regulatory and legal environment with which they operate.

2. Analysis and Discussion

2.1 Industry Analysis

     The framework to be used in the industry analysis is the Porter’s Five-forces model to examine the effects of the five forces that could reveal possible industry opportunities and threats (Porter, 1980).  Costco, Wal-Mart and BJ’s are falling under the retail industry which deals on variety of goods from on the manufacturer or wholesalers to the final consumers.

       These retailers actually offer general merchandise that may include domestics, apparel, stationery and books, housewares, shoes, home furnishings, electronics, automotive accessories, home appliances, sporting goods, camera and supplies, health and beauty products, pharmaceuticals, optical, jewelry. They also deal on grocery merchandise and even financial services as a way of increasing their revenues, photo processing services. They do these via discount stores, super centers and neighborhoods markets in the US and internationally for others. Read also Johnson and Johnson financial analysis

      An industry is defined industry as a group of firms serving the same needs and wants of customers and what would keep companies to come in to such group are basically grounded on economic reasons.  Since operating business carries with it cost of doing business, profits are expected if not necessities for survival.

       These companies or players of the industry are hoping more profitability in the industry if they have to remain as such in the industry. Companies failing meet profitability targets would end up folding up or wait till their liquidity to suffer and eventually face bankruptcy or insolvency.  In addition suffering profitability will cause decline in stock price as profitability are based on evidence of things that have happened in the past. If companies have not done well in the past, the future most probably may be believed by investors to behave in the same way for the same company unless management does the better thing. However, companies that may have come in to the industry may not necessarily get out if in so deciding there could be exit cost due to their big investments that have already been made. This part of the paper tries to evaluate what is happening in the industry at a given point and determine which are important or relevant for decision making for these companies.

         If an event or occurrence creates better profitability, then it is an industry opportunity or if it generates less profitability, it is an industry treat.  Porter’s model is useful to study the five forces that may influence the retail industry. These forces include ease or difficulty of entry, size or power of suppliers, size or power of buyers, extent of rivalries among existing firms and availability of substitutes (Porter, 1980).

          In terms of ease or difficulty of entry, there is an industry threat because new entrants can come in to the industry easily because of lack of economies of scale and the lack of need for high investment in the industry. In fact any retail store could actually become big, if willing and an investor would like to do it, because there is not much discouragement of operate such kind of business compared with starting in other industries. Read also Walmart Financial Analysis paper

         In terms power of buyers, there is also an industry threat since there are many buyers which may consist of institutional and personal buyers and they are believed to have strong bargaining power over these retailers by the fact that they can easily switch from one brand or type of goods or services to another without much cost to them and these retail companies could also deal on many products being dealt by their competitors.

     Each of the companies could not be considered to be tied to one key customer if the basis on group of people who would have to keep their purchases constant to be considered as key customer.  Moreover, each of the players is dealing with retail products which presuppose dealing with a broad category of classification of customers.  In terms of the companies’ business being generated overseas, not all of them are doing their international business.

       Among the three only Wal-Mart and Costco have their international operations which they have presented in their business segments report from their annual reports based on geographical location. Wal-Mart’s extend of international business is about 25% or less of its total revenues while that of Costco is about 20% of its total revenues.  BJ is exclusively making it revenues domestically in the US.

        In terms of power of sellers, there is an industry opportunity because suppliers of parts of products were retail are varied and these may cause them not to have a leverage over retailer. Power of suppliers of industry to retailers is therefore weak. It cannot be asserted that they each company is not relying on single a supplier as suppliers are supplying a broad or wise classifications of products as part of variety stores industry.

        There is further industry threat in the strong rivalry in the Industry.   The retail industry although may include the small retailers are actually dominated by few big retailers which include Costco, BJ’s and Walt-Mart.  The competition may still be further affected by the legal and regulatory framework that is demanded as part of the industry. This includes laws on waste materials handling and logistics handling (Supply Chain Digest, 2006). Strong rivalry will reduce industry profitability and these could be disadvantageous to present players.

         Industry opportunity appears to come from the low availability of product substitutes. This is caused by the fact that customers have no much choice but they have to use products available in the market particularly on food product which are part of the groceries needed by mankind to survive in this planet.

2.2. Financial Analysis

       The following table summarizes financial ratios extracted from the financial statements of Costco, Wal-Mart and BJ’s Wholesale Club data to facilitate analysis in terms of profitability, efficiency liquidity and solvency of the company.

Table I – Summary of Financial Ratios

Source: MSN (2008a, 2008b, 2008c,2008d,2008e, 2008f, 2008g, 2008h, 2008i)

2.2.1 Profitability and Efficiency

         Wal-Mart’s profitability is obviously highest among the three companies in terms of their average profitability ratios for the last 4 to five years.  For the purpose of this paper, the period covered for Costco is only for four years from 2004 through 2007 since its 2008 financial statements are not yet available at the time of this writing. For Wal-Mart and BJ is concerned the period covered is for five years or from 2004 through 2008.

      Based on net profit margin for years 2004, 2005, 2006 and 2007 Costco exhibited a uniform 2% for year. See Exhibit A. Its gross margin was almost the same at 12% except in 2004 when 13% was observed. Even return on assets and return on equity were maintained at 6% and 12 % respectively for the four years under review, except the return on equity (ROE) for 2007 at 13%.

        Wal-Mart in comparison has higher rates in terms net profit which was almost maintained from 3 to 4% for the five-year period from 2004 through 2008. The same can be also be said in terms of gross margin of almost more than doubled than that Costco which was maintained at 23% every except in 2004 at 22%. Even Wal-Mart’ return on assets was higher for the five period which ranges from 7% to 9%. Even the company’s return on equity was almost doubled than that of Costco within the range of 18% to 21%. See Exhibit B.

      The net profit margin and gross margin of BJ’s Warehouse Club appeared to be the lowest among three players in the retail industry.  Even in terms of return on assets and returns on equity, BJ may still be considered the lowest, although its return on assets was almost the same at that of Costco.  See Exhibit C and Table 1 above

      It is now very clear that the most profitable among the three is still Wal-Mart. Industry average which is estimated by getting the average financial ratios (Meigs and Meigs, 1995) of three companies would also bear witness to the comparison just made among the three companies. It was only Wal-Mart which had above average profitability among the three if the average their ratios are computed.

       Since Wal-Mart bested the two other using all the profitability ratios using gross margin and net profit margins, could it be safely deduced that it should be also Wal-Mart as the most efficient among the three.

       If the inventory turnover and total asset turnover are used as basis, it would appear that Costco and BJ are better than Wal-Mart. In fact, it was only Costco which has exceeded the industry averages representing the three companies if inventory turnover is used. Both Costco and BJ have exceeded the average if total asset turnover is used.  However, if the return on assets (ROA) of the companies is used as basis, it would still be Wal-Mart that is the best among the three.

      The higher inventory turn over of Costco and BJ compared with Wal-Mart may be explained by the fact that the first two companies have higher cost of sales in relation to revenue than Wal-Mart. This is with the understanding the inventory turnover is computed by dividing cost of goods sold by the inventory.  To resolve the seeming conflict of determining which is most efficient among the three, the return on assets should still be more controlling than the inventory turnover, which is used to measure how past the company replenishes the goods in the store (Meigs and Meigs,1995).

       Even the seeming conflict of better total asset turnover of Costco and BJ over Wal-Mart should give in to better ROA of the latter since although Wal-Mart is keeping longer its goods in the stores or shelves, the fact that it is generating higher gross margin would speak for the company’s better handling of its cost from goods supplied to the company. It could be further noted however that the big advantage in gross margin of Wal-Mart was almost eaten by its high operating expenses in relation to sales. This is evident by the fact that the high difference in gross margin in relation with its competitors was reduced to a minimal difference in net margin of just one percent.

      This seeming doubt on Wal-Mart high operating cost is however assured by its high ROE which bested the three and it is the only company that is above average and this time the difference as against competitors was almost close to being double. ROE speaks well in the eyes of the investors since and ROE of 20% would mean that the company would earning much more what could safely earn in risk free investments like the government treasury bills. It is already about ten times the US base rate of 2% (Housepricecrash, 2008).

2.2.2 Liquidity

         The companies’ liquidity indicates their capacity to meet currently maturing obligations, which are measured by the quick ratios and current ratios.

       BJ’s current ratios are kept at   1.19, 1.25, 1.30, and 1.23 and for the years 2004, 2005, 2005, 2007 and 2008 respectively or an average of 1.21. See Exhibit C. The fact that the company’s current ratio was maintained at above 1.0 for the fast five years may well speak of the company’s continued liquidity. Its quick ratios however are lower in comparison since its highest in the last five years has not reached 0.50 level. This means that what keeps the company liquid will have to consider its inventory and other current assets as part of the numerator in computing for liquidity.

       Quick ratio must be differentiated from current ratio, as the first although believed by some to be a better measure for liquidity, must be interpreted in the relation to the nature of the industry. This if Table 1 is used as basis, it would appear that industry average did also attain a high quick ratio. This means the industry players are not well known to have high quick ratios, but they are liquid enough to keep their suppliers being paid on time.

      Among the three companies, the most liquid is BJ’s Warehouse Club followed by Cost and the least liquid is Wal-Mart.

2.2.3 Solvency

      Among the three companies, Costco and BJ both topped solvency ratios of the three companies since both companies have the same debt to equity ratios. See Table I above.

      Solvency is almost similar to liquidity in measuring the ability of an enterprise to pay its debts but this time the issue is long-term debts of the companies.  As a distinctive characteristic, solvency tells more about long-term heath where a stable company is deemed stronger than an unstable one.  Using debt to equity ratio as an expression of solvency, Costco reflected 0.98, 0.88, 0.91 and 1.27 for the years 2004, 2005, 2006 and 2007 respectively or a four-year average of 1.01.  This obviously is better compared with Wal-Mart which reflected 1.42, 1.43, 1.60, 1.46 and 1.53 for the years 2004, 2005, 2006, 2007 and 2008 respectively or an average of 1.49.  In comparison with BJ, which reflected debt equity ratios of 1.02, 1.01, 0.96, 0.95 and 1.09 for the years 2004, 2005, 2006, 2007 and 2008 respectively or a five-year average of 1.01, Costco may be deemed to be almost as risky.

3. Conclusion

      Based on the foregoing analysis and discussion, this paper concludes that Wal-Mart is profitable although appearing least liquid and riskiest among the three companies in terms of solvency.      In terms of liquidity and solvency, Costco and BJ are definitely better than Wal-Mart but the advantage in liquidity was not that big as against Wal-Mart. between Costco and BJ, the latter is more solvent while both companies have almost the same solvency.

      The seeming conflict of better profitability not amounting or resulting necessarily to better liquidity and solvency may be explained by the fact that Costco, from the start of comparison period, had definitely better financial position than Wal-Mart; Hence, Costco’s lower profitability and efficiency have actually eroded its Costco’ liquidity and solvency in the later two years of 2006 and 2007. In case of Wal-Mart, there was actually a slight improvement in its solvency in 2007 but it declined again in 2008. In addition, Wal-Mart has been giving higher dividend to stockholders compared with Costco and BJ and it has maintained it profitability for the last five years although its liquidity and solvency were not as good as Costco and BJ.

       Although the stocks of Costco and BJ may have performed better compared to

S & P 500 Index, this paper strongly takes the position that for purpose of buying stocks, this paper recommends that of Wal-Mart because of the great potential in terms of profitability which could easily improve the company’s liquidity and solvency if the company’s management wants it. See Exhibits D, E and F. It is easier to believe that liquidity and solvency should be caused more by profitability than the other way around. If liquidity and solvency will come other than profitability, such phenomenon could doubtful if sustainable (Brigham and Houston, 2002). This steady trend of high profitability would be translated into higher stock price in the near future. The future prospects for the industry may still be considered to moderately bright despite the looming financial crisis since part of the industry are basic necessities which cannot be dispense with materially. Thus, investing or buying stocks of Wal-Mart may yet be justifies especially in the light of industry opportunities of low bargaining power of industry suppliers and low availability of product substitutes.

Appendices

Exhibit A- Costco Financial Ratios: Source; MSN 2008a, 2008b, 2008c

Exhibit B- Wal-Mart Financial Ratios: Source; MSN 2008d, 2008e, 2008f

Exhibit C-  BJ Financial Ratios: Source; MSN 2008g, 2008h, 2008i

Exhibit D –Costco Stock Graph; Source: MSN, 2008j

Exhibit E – Wal-Mart Stock Graph; Source: MSN, 2008k

Exhibit F- BJ Stock Graph; Source: MSN, 2008i

References:

Brigham and Houston (2002) Fundamentals of Financial Management, Thomson South-Western, London, UK

Housepricecrash (2008) US base rate, {www document } URL http://www.housepricecrash.co.uk/base-rates.php, Accessed October 14,2008

Meigs and Meigs (1995) Financial Accounting, McGraw-Hill, London, UK

MSN (2008a) Costco Income Statement, {www document } URL http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=COST, Accessed October 14,2008

MSN (2008b) Costco Balance Sheet, {www document } URL http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=COST&lstStatement=Balance&stmtView=Ann, Accessed October 14,2008

MSN (2008c) Costco Cash Flow Statement, {www document } URL http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=COST&lstStatement=CashFlow&stmtView=Ann, Accessed October 14,2008

MSN (2008d) Wal-Mart Income Statement ,  {www document } URL http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=WMT, Accessed October 13,2008

MSN (2008e) Wal-Mart Balance Sheet, {www document } URL http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=WMT&lstStatement=Balance&stmtView=Ann, Accessed October 14,2008

MSN (2008f) Wal-Mart Cash Flow Statement, {www document } URL http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=WMT&lstStatement=CashFlow&stmtView=Ann, Accessed October 14,2008

MSN (2008g) BJ Wholesale Club Income Statement, {www document } URL http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=BJ, Accessed October 14,2008

MSN (2008h) BJ Wholesale, Balance Sheet, {www document } URL http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=BJ&lstStatement=Balance&stmtView=Ann, Accessed October 14,2008

MSN (2008i) BJ Wholesale Cash Flow Statement, {www document } URL http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=BJ&lstStatement=CashFlow&stmtView=Ann, Accessed October 14,2008

MSN (2008j) BJ’s Warehouse Club Stock Graph, {www document } URL http://moneycentral.msn.com/investor/charts/chartdl.aspx?D4=1&ViewType=0&D5=0&&ShowChtBt=Refresh+Chart&DateRangeForm=1&ComparisonsForm=1&PeriodType=7&CP=0&PT=7&CE=0&D3=0&Symbol=BJ&C9=1&DisplayForm=1, Accessed October 14,2008

MSN (2008j) Costco Stock Graph, {www document } URL http://moneycentral.msn.com/investor/charts/chartdl.aspx?D4=1&ViewType=0&D5=0&&ShowChtBt=Refresh+Chart&DateRangeForm=1&ComparisonsForm=1&PeriodType=7&CP=0&PT=7&CE=0&D3=0&Symbol=WMT&C9=1&DisplayForm=1, Accessed October 14,2008

MSN (2008j) Wal-Mart Stock Graph, {www document } URL http://moneycentral.msn.com/investor/charts/chartdl.aspx?D4=1&ViewType=0&D5=0&&ShowChtBt=Refresh+Chart&DateRangeForm=1&ComparisonsForm=1&PeriodType=7&CP=0&PT=7&CE=0&D3=0&Symbol=WMT&C9=1&DisplayForm=1, Accessed October 14,2008

Porter (1980) Competitive  Strategy, Free Press, UK

Supply Chain Digest (2006) Wal-Mart in Trouble for Hazardous Waste Handling, {www document } URL http://www.scdigest.com/assets/newsviews/06-01-05-3.cfm?cid=144&ctype=content, Accessed October 14,2008

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