OREANDA-NEWS. Fitch Ratings has affirmed Costco Wholesale Corporation's (Costco) Issuer Default Rating (IDR) at 'A+' and has revised the Rating Outlook to Stable from Positive. Costco had $6.1 billion of debt outstanding at Nov. 22, 2015.

KEY RATING DRIVERS

Costco's rating recognizes its position as the third largest food retailer in North American, its consistently strong comparable sales (comps), and the company's robust cash flow. The Outlook revision considers the potential for debt issuance to return cash to shareholders, which could keep leverage in the mid-1x range.

Leading Position, Loyal Membership: Costco's credit profile benefits from its position as the third largest food retailer in North America with over $116 billion of annual sales. At Nov. 22, 2015, Costco operated 697 high volume membership warehouses and had a growing base of loyal members consisting of 83 million cardholders. Costco's membership and revenue have grown at a 7% - 8% CAGR over the past five years. Membership renewal has remained high at 91% in North America and 88% worldwide, providing a stable stream of fee-based revenue, and the company continues to upgrade members to Executive status which is more profitable.

Consistently Strong Comps: Costco's comps, excluding the impact of fuel and currency changes, have led industry peers growing 6% - 7% annually since fiscal 2011 (ended Aug. 2011). Growth has generally been balanced between increased guest shopping frequency and higher average ticket and has been strong across all product categories. Fitch projects Costco will generate mid-single digit comps (excluding fuel and foreign exchange) in 2016 and 2017 due to its price competitiveness, and diverse mix of high quality merchandise.

Focused Strategy; Efficient Operations: Costco offers a wide array of fast-selling products to enhance its operating efficiency and support its ability to invest in price. Warehouses maintain an average of 3,700 stock keeping units (SKUs) and are highly productive, generating more than $160 million of average annual sales. During 2015, 57% of sales were food-related products, 16% were from ancillary businesses, 16% consisted of hardlines, and 11% were softlines. Costco offers 8,000 - 10,000 SKUs on its e-commerce sites, which currently only represent about 3% of sales but is growing at a double-digit rate.

Low, Fairly Steady Margins: Costco's high volume warehouses and operating efficiency allow the company to operate profitably with low but relatively stable margins. Gross margin was 13.2% during the quarter ended Nov. 22, 2015, up from 13% in the prior year, due primarily to gas price deflation and operating EBIT margin was 3.6%, compared to 3.4%. Membership fees account for more than 60% of Costco's EBIT which Fitch believes reduces the company's earnings volatility. Fitch expects Costco's EBIT margin to remain in the low 3% range over the intermediate term.

Solid Cash Flow Generation: Cash flow from operations (CFO) has grown at a 9% CAGR since 2010 to $4.3 billion in fiscal 2015 enabling the Costco to reinvest in its business while returning cash to shareholders. FCF, excluding special dividends, has historically approximated $1 billion or more but Costco has increased capex to support a faster pace of store growth. The company expects capex to approximate $2.8 - $3.0 billion in fiscal 2016, up from $2.4 billion last year, as it opens a planned 32 new warehouses and continues to invest in its technology platform. Fitch expects FCF to average about $500 million annually over the next several years, absent additional special dividends.

Relatively Stable Leverage: Costco has opportunistically issued debt to return cash to shareholders while still maintaining conservative credit metrics. Total adjusted debt/EBITDAR has generally ranged in the low to mid 1.0x range and was 1.5x for the LTM ended Nov. 22, 2015. Fitch expects leverage to remain in the mid-1x range over the next 24 - 36 months assuming some debt-financed special dividends and/re share repurchases. Absent any debt issuance in fiscal 2016, Fitch projects total adjusted debt/EBITDAR of 1.3x reflecting the repayment of $1.2 billion of 0.65% notes that were due December 2015.

KEY ASSUMPTIONS

Fitch's key assumptions within Fitch's rating case for the issuer include:

--Revenue grows 3% in fiscal 2016 (ending August), due to the negative impact of lower year-over-year fuel prices, and then about 7% thereafter;

--Comps grow at a low single-digit rate of 2% in 2016, due to the negative impact of fuel price deflation and currency, and then grow 4% excluding the impact of fuel and currency thereafter;

--Costco's store base grows 5% annually or roughly 30 warehouses per year;

--EBIT margin of 3.5% and EBITDA margin of approximately 4.5% in fiscal 2016, due in part to the decline in sales from lower margin fuel. EBIT margin and EBITDA margin remain in the low 3% and 4% range thereafter;

--FCF averages about $500 million over the next several years, absent special dividends;

--Fitch expects leverage to remain in the mid-1x range over the next 24-36 months assuming some debt-financed special dividends and/re share repurchases.

RATING SENSITIVITIES

Positive Rating Action: Continued strong operating momentum with comp growth (excluding the impact of fuel and currency changes) in the mid- to high-single digits and stable operating margins with a public commitment to maintain total adjusted debt/EBITDAR in the low-1x range - which Fitch does not anticipate currently - could result in an upgrade in Costco's ratings.

Negative Rating Action: Sustained weakness in operating trends, caused by meaningfully lower comps (excluding the impact of fuel and currency changes) and membership declines combined with shareholder-friendly actions that lead to increased debt levels would be viewed negatively. A sustained period of total adjusted debt/EBITDAR in the high-1x range could lead to a downgrade in Costco's ratings.

LIQUIDITY

Costco's liquidity is supported by the company's significant cash and short-term investments balance. At Nov. 22, 2015, cash totaled $5.1 billion and short-term investments totaled $1.2 billion. Of the $6.3 billion total, approximately $1.4 billion was held in foreign subsidiaries and considered indefinitely reinvested. The company had $443 million of uncommitted credit facilities, of which $373 million was at international operations and $70 million was a domestic facility, at Nov. 22, 2015.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

Costco Wholesale Corporation
--IDR at 'A+';
--Senior unsecured notes at 'A+'.

The Rating Outlook has been revised to Stable from Positive.