Costco's (NASDAQ:COST) investors were pleasantly surprised when the retailer last month announced a special one-time dividend of $5 per share separate from its quarterly dividend of $0.36 per share, to be paid on Feb 27. Costco will shell out $2.2 billion for the special dividend.
Let's look at the company's balance sheet position, cash flow generation, and other underlying factors that enable it to commit such a large amount of cash to investors.
Costco's dividend: A perspective
The warehouse retailer is a decent dividend payer and has increased its payout annually since initiation in 2004. From 2005 through 2014, Costco's dividend had a compound annual growth rate of 13.4%. The company last raised its quarterly dividend in April 2014 by 14.5%.
Costco has a low payout ratio since 2005, in the range of 19.7% to 28.6%, which gives it enough scope to regularly boost its dividend and to sustain the dividend rate amid any earnings volatility.
The recent announcement marks Costco's second special dividend -- the first was for $7 per share in November 2012. The company funded that special $3 billion payout through borrowings, taking advantage of the easy lending terms prevailing at the time. These special payouts not only increase shareholder value, but also instill confidence among investors about the company's financial position and cash flow generation.
Strong balance sheet, cash flow generation
Costco has a track record of generating steady cash flow. In the first fiscal quarter ended in November 2014, Costco's net operating cash flow increased 20.1% to $1.13 billion over the year-ago period, driven by a 17% increase in profit. Membership fees increased 6% on the back of higher member sign-ups and a 90% warehouse club membership renewal rate, which led to a 7% increase in same-store sales and a 7.4% boost in quarterly net sales.
The company's cash balance was $5.97 billion at the end of the first fiscal quarter ended November 2014, while its long-term debt was $5.03 billion. This leaves net cash of $94 million in the hands of the company if it were to pay off all its debt.
Management said in a press release it will finance the special dividend by a combination of "existing cash and additional borrowings." Given the company's strong cash balance and conservative debt levels, it should not have a problem paying off investors, while not compromising on growth initiatives.
Meanwhile, the warehouse club plans to spend $2.5 billion to $2.7 billion on capital projects in fiscal 2015, up from $2 billion in the previous year.
Growth areas for Costco
Costco's earnings prospects will drive future cash flow and dividends. The retailer's next leg of growth initiatives are expected to come from e-commerce expansions and new store openings.
Costco's e-commerce business is in its early days. Though online sales form a meager 3% of total sales, its future growth prospects are undeniable. In the last reported quarter, e-commerce sales increased 20%. Costco is expanding its network to new domestic regions in the U.S. and in the international markets of Canada, the United Kingdom, and Mexico. Its recent foray into China through an online e-commerce platform received such an amazing response in the first month that the company plans to soon expand its offerings for the country.
On the brick-and-mortar front, the company aims to open 30 to 31 stores in the current fiscal year, up from its 671 warehouses currently. The new round of store openings will increase its square foot coverage by 5%.
Costco's U.S. comparable-store sales showed healthy growth last year, overcoming a severe winter in the beginning of 2014 and a difficult retail environment overall. So, apart from the new stores adding to sales, stores that have been open for over a year are also nicely contributing to the top line, despite some challenges.
The special dividend is Costco's way of delighting investors, and in the process reinforcing investors' confidence in its dividend history, financial strength, and future growth prospects. The warehouse operator is committed to increasing shareholder value, and investors should enjoy this indicator of healthy underlying business.