Target/Costco Financial Analysis

TARGET/COSTCO FINANCIAL ANALYSIS

Bob Moug, Reba Burton, Jacob Torres ACCOUNTING 202 Financial ratios 1

TABLE OF CONTENTS

Target Co. and Costco wholesale Co ...... 1 1.1 Overview (Target versus Costco financial summary)...... 1 1.2 Financial Graphics ...... 7 1.3 Financial Statements...... 9 1.4 Financial ratios ...... 16 1.5 Ratio detailed Analysis ...... 17 1.5.1 Liquidity and Efficiency ...... 17 1.5.2 Solvency ...... 19 1.5.3 Profitability ...... 20 1.5.4 Market Prospects ...... 22 1.6 Conclusion ...... 23 Bibliography ...... 28

Financial Analysis

TARGET CO. AND COSTCO WHOLESALE CO

1.1 OVERVIEW (TARGET VERSUS COSTCO FINANCIAL SUMMARY)

Our financial analysis will cover two Fortune 500 companies Target Corporation and

Costco. We will start out this analysis by giving a brief history of both companies and comparing both companies against each other using five ratios; current, quick, debt-to-equity and dividend yield. A visual graphic representation of these five ratios will be at the end of the comparison narrative. Then we will have an overview of 12 additional ratios relevant to the 2 liquidity, solvency, profitability and market prospects of each company and how they compare against each other and the industry. Finally we will conclude this analysis with our opinion of which company is more favorable to invest in.

“Target Corporation was incorporated in Minnesota in 1902.” (TGT Annual Report pg. 2)

Target likes to refer to their customers as “guests” and take pride in offering their guests a wide range of options for buying their products.

“Their general merchandise stores offer an edited food assortment, including

perishables, dry grocery, dairy and frozen items while their Super Stores offer a full line

of food items comparable to traditional supermarkets. Their new urban format stores,

City Target and TargetExpress, offer edited general merchandise and food assortments.

Their digital channels include a wide assortment of general merchandise, including many

items you can find in their stores, along with a complimentary assortment such as

additional sizes and colors only sold online” (TGT Annual Report pg. 2).

In 2013 the Target Corporation suffered a massive data breach. “Up to 40 million shoppers had their credit card data stolen during the breach, while up to 70 million had personal information such as addresses and phone numbers stolen.” (Washington Post)

However, in Target’s 2014 Annual report they state that, “Until the Data Breach in the fourth quarter of 2013, all incidents we experienced were insignificant. The Data Breach we experienced was significant and went undetected for several weeks. Both we and our vendors have experienced data security incidents other than the Data Breach; however, to date these other incidents have not been material to our consolidated financial statements.” (TGT Annual

Report pg. 7) In spite of the aforementioned data breach the Target Corporation has continued to grow and improve in their market and giving their guests the safe experience they deserve 3 both in their stores and online by creating a new position in their company, a Chief Information

Security Officer.

Prior to January 2015 Target exited their Canadian Segment. Target’s annual report also boats that “Virtually all of their revenues from continuing operations are generated within the

United States and the vast majority of their long lived assets re located within the United

States.” (TGT Annual Report pg. 4) Target owns and operates a total of 1,790 U.S stores as of their January 31, 2015 Annual report. Of those stores 1,536 of those are owned by Target, 99 are leased and 155 are owned buildings on leased land.

“Costco Wholesale Corporation and its subsidiaries began operations in 1983 in Seattle

Washington. In October 1993, Costco merged with the Price Company, which had

pioneered the membership warehouse concept, to form Price/Costco, Inc. a Delaware

Corporation. In January 1997, after the spin-off of most of its non-warehouse assets to

Price Enterprises, Inc., the Company changed its name to Costco Companies, Inc. On

August 30, 1999, the Company reincorporated from Delaware to Washington and

changed its name to Costco Wholesale Corporation.

As of December 2014, the Company operated a chain of 671 warehouses in 43 states,

Washington, D.C., and Puerto Rico (474) locations, nine Canadian Provinces (88)

locations. Mexico (34 locations), the United Kingdom (26) locations, Japan (20

locations), Korea (11 locations), Taiwan (10 locations through a 55%-owned subsidiary),

Australia (seven locations) and Spain (one location). The Company’s online business

operates websites in the U.S., Canada, U.K. and Mexico.” (COST Annual Report under

the Company) 4

Now that we have commenced with a brief overview of each company how do they compare to each other. We will begin this company comparison with five ratios; current, quick, debt-to-equity and their dividend yield. There will be a visual representation of these figures after the narrative. After calculating and reviewing the current ratio analysis of both Target and

Costco we see that Targets ratio is 1.2 to 1 while Costco has a ratio of .99 to 1. Even though

Costco’s ratio is smaller it appears that both companies have enough working capital to meet their current obligations. The current ratio however, is not the only way to determine whether

Target or Costco can payback their current obligations. When you look at the quick ratio, also known as the acid test ratio, which measures immediate liquidity of both companies; Target’s ratio is 0.19 while Costco has a ratio of .48. Meaning that Costco for instance has $0.48 of liquid assets to cover each $1 of current liabilities and Target has $0.19 of liquid assets to cover each $1 of current liabilities. By looking at just these two ratios Costco seems more able to meet their short term obligations. Both of these ratios attest to the liquidity of each company.

Now liquidity is not the only important factor when analyzing a company we must also look at the solvency of each company. We must measure their ability to generate future revenues and meet long-term obligations. Here, we turn to the debt-to-equity ratio this ratio measures the financial leverage of Target and Costco by indicating what portion of debt and equity they are using to finance their assets. Target’s debt-to-equity ratio is 1.96 while Costco’s is 2.22.

Target’s lower number suggests that there is a low risked for creditors and strong, long-term, financial security for the company. However, Costco’s 2.22 debt-to-equity ratio while hire than

Target shows a solid performance in this area for the company as well. So far both companies seem to be comparing evenly with each other. Another factor that should be considered in a 5 comparative financial analysis of companies is their profitability. How can you compare Target and Costco’s ability to provide financial rewards sufficient to attract and retain financing? We can look at their return on total assets ratio (ROTA). We have conducted the ROTA to find that

Target’s ratio is 2.8% and Costco’s ROTA is 3.34%. These percentages tell us that Costco was able manage their assets more efficiently and produce a profit over the analyzed period. “A higher ratio is more favorable to investors because it shows that the company is more effectively managing its assets to produce greater amounts of net income. A positive ROTA ratio usually indicates an upward profit trend as well.” (Myaccountingcourse.com ROTA) Our final analysis for the beginning comparisons for this report will cover each company’s market prospects by “measuring the amount of cash dividends distributed to common shareholders relative to the market value per share” using the dividend yield ratio for Target and Costco. “A company with a high dividend yield pays its investors a large dividend compared to the fair market value of the stock. This means the investors are getting highly compensated for their investments compared with lower dividend yielding stocks. A high or low dividend yield is relative to the industry of the company; so even a small dividend might produce a high dividend yield ratio. (Myaccountingcourse.com DYR). Target’s dividend yield is 0.65% while Costco’s dividend yield is 0.22%.

According to Target’s 2014 Annual report they have “paid dividends every quarter since their 1967 initial public offering, and it is their intent to continue to do so in the future. In this analyzed period Target paid dividends totaling $1,205 million and declared dividends totaling

$1,271 million for 2014.” (TGT Annual Report pg. 22) 6

When we take a look at Costco’s annual report they state that “their Board of Directors increased their quarterly cash dividend from $0.31 to $0.335 per share. Their cash dividends paid out in 2014 totaled $584 million. They also presently expect to pay dividends on a quarterly basis.” (COST Annual Report pgs. 2, 22 and 32)

Below you will find the visual graphics of the ratios previously discussed.

1.2 FINANCIAL GRAPHICS Target Graphics

Costco Graphic

1.3 FINANCIAL STATEMENTS

Target financial statements

Costco Wholesale financial statements

1.4 FINANCIAL RATIOS Target Costco Wholesale Liquidity Ratios 2015 2015 Current ratio 1.20 0.99 Quick ratio 0.19 0.48 Accounts receivable turnover 47.78 33.60 Inventory turnover 6.01 5.56 Days’ Sales in Inventory 60.75 65.67 Total asset turnover 1.69 1.60 Solvency Debt ratio 0.66 0.69 Equity ratio 0.34 0.31 Debt to equity ratio 1.96 2.22 Times Interest Earned 4.14 31.11 Profitability

Profit Margin after tax 1.66% 2.09% Gross margin 29% 13% Return on total assets 2.80% 3.34% Return on common stockholders’ equity 8% 10% Book Value per common share 21.86 23.32 Market Prospects

Price-earnings ratio 121.27 134.67 Dividend yield 0.65% 0.22%

1.5 RATIO DETAILED ANALYSIS

1.5.1 Liquidity and Efficiency

Detailed Ratio Analysis

Activity Ratios

Activity ratios delivers a useful gauge of a company’s operations by determining the average number of days it takes to collect on customers’ accounts and the average number of days to pay vendors. Accounts receivable turnover Credit sales for the year/ the average accounts receivable during the year This ratio measures the number of times receivables turn over in a year and reveals how successful a company is in collecting its outstanding receivables. A higher number is good for the company because it indicates a shorter time between sales and cash collection.

The accounts receivable turnover for Target 38.83, which compared to Costco of 33.60. Suggest that Target takes 38.83 times collecting cash from sales through the year and Costco take 33.6 times it takes to collect cash from sale. Both companies have an efficiency in collecting its receivables

Inventory Turnover Cost of goods sold for the year/ the average inventory during the year This ratio measure the cost in inventory to the cost of goods sold and compare the quantity of each item in inventory with the recent sales of each item. The higher the inventory turnover ratio, the better, because it means that a company is able to fill customers’ orders on time.

The inventory turnover for Target is 6.01 times, which compared to Costco of 5.56 times. Suggests that Target is able to turnover inventory with a small investments than Costco. Also, the average Discount Variety Industry inventory turnover is 3.3. Therefore both companies could either have strong sales or ineffective buying

Days’ Sales in Inventory

365 days/ the inventory ratio

This ratio measures the average number of days that it took to sell the average amount of inventory held during the specified one-year period. In other words, how many days it takes to sell the merchandise held in inventory.

Days' Sales in Inventory The days’ sales in inventory ratio for Target is 60 and 3/4 days, 60.75 which compared to Costco of 65 and 1/3 days. This indicates 65.67 that Target have less time to turn inventory into sales than 70.00 Costco. The Discount Variety store average is 75 days, this Target 60.00

indicates that both companies are doing fairly well among SCORERATIO Costco 50.00 competitors Costco Target

Total Asset Turnover

Total revenues for the year / the average total assets during the year

This ratio measures the relationship of net sales for a specific year to the average amount of total assets during the current 12 months. Meaning, how efficient is the company using its asset to generate sales or income to the company. The higher the ratio is ideal since it means the company is generating more revenues per dollar of assets. 19

Total asset turnover The total asset turnover for Target is 1.69, which compared to 1.69 Costco 1.60. Indicates that Target is operating efficiently than 1.60 Costco. The average Discount Variety Industry ratio is 1.3.This 1.80 Target indicates that both companies is favorable among other 1.60 Costco competitors of operating efficiently. SCORERATIO 1.40

Costco Target

1.5.2 Solvency

Solvency ratios Solvency ratios measure a company’s ability to cover long-term obligations and the company long-run financial viability. In other words, can both companies be able to continue in business in the long run to meet its long-term obligations? Debt Ratio Total liabilities/ total assets This ratio measures the company’s ability to pay of its liabilities with its total assets. In other words, how many assets the company must sell in order to pay off all of its liabilities. Any ratio under 1 is consider to be often low risk for lenders. A favorable debt ratio will be 0.5 since it means the company has twice as many assets as liabilities.

Debt Ratio The debt ratio for Target is 0.66 which compared to Costco of 0.69. Suggests that both companies are consider to be 0.66 0.69 less risky for lenders and to continue to meet liabilities as 0.70 Target low ratio 0.66 is more favorable than Costco ratio Target 0.65

of 0.69. SCORERATIO Costco 0.60

Costco Target Equity Ratio Total Owners equity/ Total assets This ratio measures the amount of assets that are supported by owners’ investments, comparing the total equity in the company to the total assets. The equity ratio shows if the company can have remaining assets after liabilities is paid off and how leveraged the company 20 is with debt. A high equity ratio is great for the company since its shows potential growth for shareholders that the company is worth investing and tell creditors that the company is more sustainable and less risky for future loans

Equity Ratio The Equity ratio for Target is 34 percent, which 0.34 compared to Costco of 31 percent. This ratio indicates 0.31 that the both companies is funding less assets and more 0.35 Target debt. Target is the more favorable company since 34 0.30 Costco 0.25 percent of assets are earned by shareholders and only SCORERATIO 1 31 percent of Costco assets are owned by shareholders. Costco Target

Times Interest Earned Earnings before Interest and Taxes/Interest Expense This ratio measures the company’s ability to meet interest payments. A higher number is preferred suggesting a company can easily meet interest obligations and can take on additional debt. A ratio less than 1 means the company is likely to have problems paying interest on its borrowings.

The times interest earned ratio for Target is 4.14 times, Times Interest Earned which compared to Costco of 31.11times. Indicates that 4.14 the both companies is sufficient on paying interest on its 31.11 borrowings. Costco has a high ratio which may result of 50.00 Target the fact the company lack of debt is paying too much of Costco RATIO SCORERATIO 0.00 its earnings on debt that could have been spend on other projects. Costco Target 1.5.3 Profitability

Profitability ratios Profitability ratios measure a company’s ability to use its assets efficiently to produce profits. In other words, can both companies Target and Costco Wholesale be able to generate an acceptable return on invested capital?

Profit Margin Net income / net sales This ratio is a percentage that measures how much out of every dollar of sales a company actually keeps in its earnings. A high profit margin indicates the company is more profitable and has better control over its costs compared to its competitors.

The profit margin of Target is 3.37%, which Profit Margin compared to Costco of 2.09%. Suggest that Target is more profitable and compared the Industry 3.37% 2.09% average of 2.7%. Target ha better control over its 5.00% Target costs compared to other competitors Costco

0.00% RATIO SCORERATIO

Costco Target Gross Margin

Gross profit/Net sales

This ratio measures the percent of sales revenues that the company retains incuring the cost of goods and services sold by a company. A high percentage is ideal for a company, since it will increase the dollar of sales to service its other costs and obligations.Also a high ratio indicates the company has more money to pay operating expenses like wages, utlities and rent

Gross Margin The gross margin of Target is 29%, which compared to Costco of 13% . Indicates that Target has a stronger ratio than the 29% 13% average discount variety Industry of 24.8%.Target is more 50% Target effiecient in selling its inventory and Costco is unfavorable Costco 0% compared to its competitors. SCORERATIO Costco Target

Return on common stockholders’ equity

Net income after taxes for the year / the average stockholders’ equity during the year

This ratio measures the success of a company in generating income for the common stockholders equity.A high ratio indicates high proitability and strong financial postion of the company and can convert potential investors into acutal common stockholders 22

Return on stockholders' The return on equity of Target is 8%, which compared to Costco of equity 10%. Indicates that both companies is a not really using investor 8% money effectively comared to avergae industry ratio return on 10% equity of 24%.Costco is look more favorable than target but an 10% Target Costco average of 5 to 10 years gives a better prospective of the growth of 0%

the company. SCORERATIO Costco Target

Book value per common share

Amount of stockholders’ equity / the number of shares of common stock outstanding

This ratio measures investors evel of safety associated with each individual share after all debts are paid accordingly or in other words liquidating assets.

Target book value per common share is 21.86, which compared to Book value per common Costco 23.32. Indicates that Targets is overvalued from the market share 21.86 share of 88 to 21.86. Costco is consider overvalued of 138.32 to 23.32 23.32. Investors is expected to received the book value when the companies liquidate their assets. 25.00 Target Costco 20.00

SCORERATIO Costco Target

1.5.4 Market Prospects

Market Prospects Market measure are useful for analyzing corporations with publicly traded stock .In other words, can both companies Target and Costco Wholesale be able to continue to provide positive return to stockholders?

Price-earnings ratio

Market price per common share / earnings per share

This ratio is a valuation of a company’s current share price compared to its share earnings. A high ratio around 20 indicates the company is making money for investors. A low ratio of 15 or less is the company is losing money. (MyaccountingCourse)

Price-earning ratio Target valuation is 121.27, which compared to Costco of 134.67.This ratio indicates both companies are valuate as 121.27 134.67 profitable making money for investors. Costco is the most favorable of its valuation as a higher growth in the future is 150.00 Target expected. Costco RATIO SCORERATIO 100.00

Costco Target

1.6 CONCLUSION Summary of Financial Performance for Target versus Costco Both Target and Costco have financial statistics that show why they are still large competitors in the retail store industry. Although their retail stores differ in some ways, Target keeps a larger variety of inventory in store immediately available for purchase, Costco is more of a warehouse type retailer with a lot of product available online and select inventory at the retail locations. The financial statements for 2014 show very similar patterns in many areas. After reviewing both companies’ financial statements and comparing performance, the following will summarize the key points. 24

Liquidity

Current ratio and acid test ratio

Average current ratio for Target was 1.2 and acid test ratio was 0.19. These averages are larger in the current ratio aspect but not as large in the acid test ratio in comparison with

Costco current ratio of 0.99 and acid ratio test was 0.48, which reflects Targets ability to pay short term debt a little better than Costco but in the immediate short term debt paying ability,

Costco had a larger average. A current ratio score of less than one is not a preferred current ratio score; however, Costco had a gross income increase of 8% between 2013 and 2014 which should not raise concern about the lower ratio for Costco.

Collection

Target has a better ability to collect customer payments with a ratio of 47.78% in comparison to Costco who holds a 33.6% ratio for accounts receivable turnover. This higher percentage for Target reduces the liability for risky accounts receivable. With the faster turnover, this allows Target to pay for its inventory outright and keep their short term debt amounts minimal in comparison to Costco who takes longer to collect on their accounts and in turn holds short term debt longer costing them additional interest fees and decreasing their working capital.

Days to sell Inventory

Costco’s inventory holding period was 5 days longer than Target which is not substantial, but if that inventory is financed there can be fees that come with the retention. Moving inventory 25 efficiently and effectively reduces the possibility of increased capital financing, again allowing

Target to have more working capital.

Solvency

Debt to Equity Ratio

Costco held a higher ratio of debt to equity at 2.22% in comparison to Target who has an average ratio of 1.96%. This shows that both companies have equal debt financing. Having debt from creditors can be harmful to a company in many ways, liability of debt being the largest factor, interest accrual being another, with an average ratio that these two companies have, there may be reason to hold a certain amount of debt to creditors, but if equity financing is involved in lieu of creditor financing, there would become more shareholders thereby decreasing earnings per share of the shareholders currently in the system.

Profitability

Profit margin ratio

Target holds a smaller profit margin after tax ratio of 1.66 than that of Costco which is at

2.09. The larger profit margin ratio by Costco shows how the company gets the most profit possible from its total revenue. One of the most important ratio aspects is return on assets.

This reflects a better ability of a company to efficiently use its assets and create higher earnings from products sold per company asset. The return on total assets for Target is 2.8% which is smaller than Costco which has a return ratio of 3.34%, reflecting more efficiency in utilizing their assets and creating higher earnings. 26

Return on equity and assets

Return on equity is an important ratio for potential investors as this reflects the return investors will receive on their investment. Target currently has an 8% return on equity and although this is a good return, Costco currently has a 10% return rate which will be more attractive to investors due to the larger return. The larger return on Costco equity is a reflection of a more efficient operation by management and the employees which creates increases in revenue.

Market Measures

Price to earnings ratio and dividend yield

The price to earnings ratio for Target is 121.27 which shows that the investors are less interest in of their stock, compared to Costco earnings ratio of 134.67 which reflects investors having higher expectations of the company performance levels and are willing to pay higher prices for their stocks for an expected increase in their return on equity.

Dividend yield ratios are different between the two companies with a larger yield for Target who currently has a 0.65% yield and Costco holds a 0.22%. This ratio represents the amount of earnings generated for every dollar invested.

Summary of Financial Performance 27

After reviewing both companies’ financial statements and discussing their performance with my team members, there are some areas where Target shows better ratios than Costco in financial management, but in further review the decision to recommend Costco for investment purposes is a better choice due to higher return on Equity rates to stockholders and less overall liability. Review of both company’s assets has revealed Target has several discontinued stores in their inventory, which is not a sign of strength in sales. Costco on the other hand has shown nothing but growth and stability during the same timeline, which would be an indicator the market, was there for customers. Costco continues to show marked improvement in sales with an uprising trend continuously over the past five years. My recommendation to Target would be to operate more efficiently and effectively, paying close attention to product inventory and demand markets to provide the best possible service to consumers available. Increasing their security system to keep customers personal information protected should be a huge concern for them considering they have had a few breaches in their system which reflects on their financial reports as consumers lost confidence and trust in their security, gaining the customers trust may help sales for Target.

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