A True Genious at Dividends

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On December 18, Costco (NASDAQ: COST) paid its shareholders a special dividend of $7 per share. The objective behind this was to protect its shareholders from high dividend taxes amid fiscal cliff. Costco’s competitor, Wal-Mart (NYSE: WMT), did pay accelerated dividends on the December 27, but didn’t issue any special dividends. Now, the million dollar question is will Costco continue to give substantial dividends to its shareholders in the future as well?

When analyzing future dividend payments, one must look at company’s free cash flows and its revenue growth.

OCF & FCF Analysis

In 2012, Costco reported an operating cash flow of 3.50 billion, while its Capex (capital expenditure) was 1.48 billion. Hence, a free cash flow (FCF) of 2.02 billion.

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According to the estimates, projected sales growth for 2013 and 2014 is 7.40% and 8.5% respectively, which implies an estimated FCF of $2.36 billion in 2013 and $2.56 billion in 2014. Moreover, the total FCF available to Costco would be around $2.78 billion at the end of 2015.

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Debt Issued to Finance Special Dividends

In order to finance its special dividends, Costco issued debt of $3.5 billion. According to the company, $3 billion of this was used up on special dividends and the rest was used for other expenses. Debt issued by Costco is payable in three separate terms, one in December 2015, second in December 2017, and the last one in December 2019. According to the company’ CFO, Costco has an access to relatively cheap debt (available at 1.5%) in the market so markups won’t be an issue for them.

But, the matter of fact is that will Costco have enough cash in December 2015 so that it could easily pay off its first installment without hurting its dividends? The answer might well be “yes.” If we use 2013 estimates, Costco looks all set to reach an FCF of almost $2.78 billion by the end of 2015, which is more than enough to pay off its first installment and its quarterly dividend of $0.275 (assuming COST will pay the same dividend per share in 2015).

Dividend Coverage = LFCF / Dividends = 1.78b / 450m = 3.95 times

After deducting $1 billion debt from an FCF of $2.78 billion, we get to a levered free cash flow (LFCF) of $1.78 billion. A strong Dividend Coverage of 3.95 in 2015 clearly shows that the company would not only be able to sustain its current dividend per share, but would also be able to grow it in the future. In short, financing its special dividends of $7 per share hasn’t hurt Costco’s growth in the long run.

Competitors

When we compare Costco with other competitors in the industry, we find out that it’s yielding far lesser on its dividends. But, when we add Costco’s special dividend of $7 per share in its yield, it comes out to be 8%, which is far greater than its competitors. Hence, a payout ratio far greater than its industry’s competitors.  

<table> <tbody> <tr> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>Payout ratio</strong></p> </td> <td> <p><strong>Dividend Yield</strong></p> </td> </tr> <tr> <td> <p><strong>Costco</strong></p> </td> <td> <p>27%</p> </td> <td> <p>1.10%</p> </td> </tr> <tr> <td> <p><strong>Wal-Mart</strong></p> </td> <td> <p>32%</p> </td> <td> <p>2.30%</p> </td> </tr> <tr> <td> <p><strong>Target</strong></p> </td> <td> <p>32%</p> </td> <td> <p>2.4%</p> </td> </tr> </tbody> </table>

 Conclusion

Just like 2012, 2013 is expected to be a great year for Costco. With a ROE of 14.72%, it’s certainly minting a lot of money for its shareholders. Previously, Costco was sometimes criticized for not being good enough for its shareholders. However, this time around, the company did a great job of giving special dividends to its shareholders; hence, showing its great intent of rewarding the ultimate stakeholders. Having said this, company’s efficient planning of financing its special dividend should also be appreciated. The bottom line is that Costco will continue to give its shareholders a consistent if not a growing dividend in the years to come.


Vamosrafa7 has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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