DBRS Confirms Costco at A (high), Changes Trend to Negative on Short-Term Rating

DBRS has today confirmed the Issuer Rating of Costco Wholesale Corporation (Costco or the Company) and Costco Wholesale Canada Ltd. at A (high) with a Stable trend. DBRS has also changed the trend on the Commercial Paper, rated R-1 (middle), to Negative from Stable.

Although DBRS expects Costco’s earnings profile to remain strong and stable due to its dominant position in the warehouse club segment, its efficient operations and its resilience to economic cycles, we expect the Company to continue with the trend of more aggressive financial management that it started in F2007.

Rising capex and dividends have caused free cash flow (before changes in working capital and after dividends) to decline toward the breakeven level over recent periods and are expected to increase further from recent highs as Costco continues with its ambitious store expansion plan. DBRS forecasts that free cash flow may move into negative territory for the first time in years. DBRS also expects Costco to continue with meaningful levels of share repurchases over the medium term, which would effectively by financed by an increase in net debt.

The magnitude of any negative free cash flow and debt-financed share repurchases will determine the extent of the pressure on the Company’s financial and liquidity profiles. DBRS views the R-1 (middle) short-term rating as being more susceptible to these factors than the long-term rating, for which there is considerably more room to manoeuvre within its current category.

In terms of profitability, Costco continues to perform well in general and has displayed some improvement recently. Same-store sales growth rate accelerated marginally over the course of F2007 and year-to-date F2008 as a result of increased member spending and moderating expansion by Sam’s Club. Operating margins have displayed some recovery from the low point experienced in H1 F2007 as Costco has benefited from foreign exchange movements, improved sales mix, enhanced operating leverage and strong expense control in general.

Going forward, DBRS expects the composition of strong top-line growth to be roughly balanced between same-store sales and contribution from new stores. Sales should continue to benefit from superior relative performance during the down portion of the economic cycle. DBRS expects operating margins to remain relatively steady through the remainder of F2008 and into F2009 as improving operating leverage, pricing and product mix should offset most of the impact of rising costs.

Notes:
All figures are in U.S. dollars unless otherwise noted.
Issuer ratings apply to all general senior unsecured obligations of the issuer in question.