Fitch Affirms Costco's IDR at 'A+'; Outlook Revised to Positive

CHICAGO--()--Fitch Ratings has affirmed Costco Wholesale Corporation's (Costco) Issuer Default Rating (IDR) at 'A+' and revised the Rating Outlook to Positive from Stable. Costco had $5.3 billion of debt outstanding at Aug. 31, 2014. A full list of rating actions follows at the end of this release.

The affirmation reflects Costco's strong competitive position, healthy operating performance, and ample free cash flow and liquidity. The Outlook revision reflects the expectation that financial leverage will improve to the low 1x range over the next year with the anticipated repayment of $1.2 billion of notes that mature in December 2015.

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 $164 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% in each of the past four fiscal years (ending August) - compared to growth at Sam's Clubs that has ranged from 1% - 5% over the past four years, and an estimated 3% industry growth in the categories it competes in. In addition, membership renewal rates in the U.S. and Canada have remained high at around 91%.

Costco's EBIT margins have been steady at 3.1% to 3.2%, and Fitch expects margins to remain in this range going forward. Free cash flow after dividends was $1.4 billion in fiscal 2014, but is expected to track between $500 million - $700 million over the next three years as capital expenditures increase to $2.5 billion - $2.7 billion from $1.5 billion in fiscal 2012, to support a faster pace of new store growth both in the U.S. and internationally. Costco is expanding its square footage at a 3% - 4% rate in North America and a double digit rate in other regions, with a continued focus on Asia.

Adjusted leverage increased from 0.8x at fiscal year-end 2012 to 1.6x at fiscal year-end 2013 due to the issuance of $3.5 billion of notes to finance a special dividend. Adjusted leverage is expected to improve to the low-1x range in fiscal 2016 and thereafter, on mid-single digit EBITDA growth and the expected pay down of $1.2 billion of notes maturing in December 2015.

Costco repurchased $334 million of its shares in fiscal 2014, following only $36 million of repurchases in fiscal 2013, and Fitch expects ongoing share repurchases will be financed with free cash flow and existing cash.

RATING SENSITIVITIES

Positive: Continued strong operating momentum, with top line growth in the mid-to-high single digits and steady operating margins, combined with a sustained reduction in lease-adjusted leverage to the low-1x area on a sustainable basis could lead to a positive rating action.

Negative: Sustained weakness in operating trends and 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 revised to Positive from Stable.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=925135

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Contacts

Fitch Ratings
Primary Analyst
Philip M. Zahn, CFA
Senior Director
+1 312-606-2336
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Monica Aggarwal, CFA
Senior Director
+1 212-908-0282
or
Committee Chairperson
Craig Fraser
Managing Director
+1 212-908-0310
or
Media Relations:
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Philip M. Zahn, CFA
Senior Director
+1 312-606-2336
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Monica Aggarwal, CFA
Senior Director
+1 212-908-0282
or
Committee Chairperson
Craig Fraser
Managing Director
+1 212-908-0310
or
Media Relations:
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com