DBRS Limited (DBRS Morningstar) upgraded Costco Wholesale Corporation's (Costco or the Company) Issuer Rating and Senior Unsecured Debt rating to AA (low) from A (high) and upgraded Costco's Short-Term Issuer Rating to R-1 (middle) from R-1 (low).
DBRS Morningstar also changed all trends to Stable from Positive. The upgrades reflect strengthening in the Company's earnings profile over the last few years, underpinned by the strong and steady growth rate of Costco's business and membership model, and are independent of the recent positive impact on operating results driven by the Coronavirus Disease (COVID-19) pandemic, which DBRS Morningstar views as temporary in nature. While uncertainties related to the intensity and duration of the coronavirus pandemic as well as its macroeconomic aftereffects remain, the Stable trends reflect DBRS Morningstar's view that Costco is well positioned to navigate the current environment within the new AA (low) rating category. The ratings are supported by the Company's large size, improved market position, improved operating efficiency, relative resilience to economic cycles, and the annuity-like benefits of its membership model. The ratings also continue to consider the intense competition and risks associated with geographic expansion.
On September 13, 2019, DBRS Morningstar changed Costco's trends to Positive, based on the Company's strengthening earnings profile over the last few years. Furthermore, DBRS Morningstar acknowledged that the continued use of debt-funded special shareholder dividends, which has constrained the ratings in the past, no longer constrains the ratings because it has become consistent financial management practice, and, more importantly, comes from a position of a stronger earnings profile. At the time, DBRS Morningstar stated that if Costco maintained relatively stable operating performance, the Company's ratings could be upgraded to AA (low).
Since then, Costco has reported results for the fiscal year ended August 30, 2020 (F2020), during which operating results remained in line with DBRS Morningstar's expectations and supportive of the ratings upgrade independent of the temporary positive effects related to the coronavirus pandemic, which include a significant increase in sales volume and meaningfully higher operating costs.
During the first six months ended February 16, 2020 (H1 F2020), Costco's operating results were in line with DBRS Morningstar's expectations with revenues increasing 8% year over year (YOY), primarily driven by a 6% increase in comparable sales (excluding the impact of changes in foreign currency and gasoline prices). Operating results were significantly affected during the second half of F2020 by the outbreak of the coronavirus pandemic. Sales of the Company's core merchandise categories, primarily food and sundries and fresh foods, increased significantly as a result of the coronavirus pandemic while its ancillary business saw material decline. As such, Costco's revenues increased 9.2% YOY to $167 billion in F2020, and comparable sales increased 9% YOY. EBITDA margins remained relatively stable at 4.2% as improvements in operating leverage were largely offset by coronavirus pandemic-related operating costs related to the health and safety of employees and customers.
Going forward, DBRS Morningstar expects Costco's earnings profile to remain relatively stable, primarily driven by modest revenue growth while EBITDA margins are expected to remain largely stable over the medium term following the normalization of coronavirus pandemic-related impact on operating performance. DBRS Morningstar expects revenues to grow by mid-to-high single digits to reach approximately $180 billion in F2021, driven by mid-digit comparable sales, low-20s new warehouse openings, and growing e-commerce penetration. DBRS Morningstar expects EBTIDA margins to remain relatively stable as increased coronavirus pandemic-related costs, including incremental wages and sanitation expenses, are expected to partially offset operating leverage gains. As such, DBRS Morningstar forecasts EBITDA to grow to approximately $7.4 billion in F2021.
Over the medium term, DBRS Morningstar expects Costco's financial profile to remain relatively stable and commensurate with the AA (low) rating category, primarily driven by growth in operating income and taking into consideration the possibility of temporarily weakening credit metrics as a result of debt-financed special shareholder returns. DBRS Morningstar expects cash flow from operations to track operating income while capital expenditures (capex) are expected to be approximately $3.1 billion in F2021. Capex is expected to primarily focus on approximately 20 new store openings and e-commerce initiatives. DBRS Morningstar expects Costco to continue its practice of intermittent debt-financed shareholder returns, as evidenced by the Company's recent announcement of a $10 per share special dividend for a total outlay of approximately $4.4 billion, which may result in a temporary weakening of credit metrics. DBRS Morningstar notes, however, that it has become a consistent financial management practice, and, more importantly, it comes from a position of a stronger earnings profile. As such, credit metrics should improve modestly within the current rating category over the medium term and remain commensurate with the AA (low) rating category (i.e., adjusted debt-to-EBITDA of approximately 1.50 times).
ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
Notes:
All figures are in U.S. dollars unless otherwise noted.
The principal methodologies are Rating Companies in the Merchandising Industry (July 30, 2020) and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2, 2020), which can be found on dbrsmorningstar.com under Methodologies & Criteria.
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrsmorningstar.com.
This rating was not initiated at the request of the rated entity.
The rated entity or its related entities did not participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
This is an unsolicited credit rating.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.
For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.
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Ratings
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01-Dec-20 Issuer Rating Upgraded AA (low) Stb CA
01-Dec-20 Issuer Rating Trend Change A (high) Stb CA
01-Dec-20 Short-Term Issuer Rating Upgraded R-1 (middle) Stb CA
01-Dec-20 Short-Term Issuer Rating Trend Change R-1 (low) Stb CA
01-Dec-20 Senior Unsecured Debt Upgraded AA (low) Stb CA
01-Dec-20 Senior Unsecured Debt Trend Change A (high) Stb CA
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COSTCO WHOLESALE CORPORATION 
