Retail

Costco Dividend and Buyback Scorecard

Along with earnings season in January and April, there are hundreds of large companies which take the opportunity to yet again raise their dividends and/or announce big share buybacks. News that Costco Wholesale Corporation (NASDAQ: COST) was increasing its dividend and adding a large share buyback plan looks stronger than what most investors might have been anticipating on the surface. The question is whether these two efforts will move the needle when you consider Costco’s much higher market valuation compared to other big retailers.

Costco’s board of directors reauthorized a common stock repurchase program of up to $4 billion. This new buyback program has a five-year life and will expire in April 2019. What investors should know is that the new plan effectively replaces the prior $4 billion buyback program. Where the plan gets interesting is that the expiring plan was set to end later this April, and it had an unused authorization remaining of about $2.5 billion.

In short, Costco had only bought back $1.5 billion worth of its stock under the prior buyback plan. This suddenly seems rather unimpressive for a $64 billion market value — or does it?

What investors have to keep in mind is that Costco really has a hard time buying back its stock. The problem is not just that the stock trades at 28 times expected earnings. That is a high valuation for a retail giant of its size. The real issue is that Costco shares have drifted higher and higher through time, hitting all-time highs as recently as February.

Stock buybacks have been big drivers of stocks, but some companies simply do not want to misallocate cash by buying back stock at a huge premium compared to recent years. Costco has to decide whether it wants to pursue growth property targets where it can to drive more growth in the years ahead or whether it should pay a much higher market multiple than its peers to buy back stock.

And what about Costco’s dividend hike?

Its board of directors declared a quarterly cash dividend on its common stock, raising it from $0.355 to $0.40 per share. This is now to be $1.60 per share on an annualized basis, which generates a yield of about 1.1%.

Costco would almost certainly like to have a higher dividend yield than 1.1%. Target has a 2.5% yield and Wal-Mart has a 2.4% dividend yield. Still, Costco is growing faster and that means it doesn’t have to pay more out. The new $1.60 annualized payout compares to  annual earnings expectations of $4.89 EPS for the current year and $5.17 EPS for the next year. In short, this is a payout ratio of almost one-third of earnings per share without factoring in share buybacks.

Investors had Costco shares up 1.5% at $146.70 late on Monday. Some of the gains can be attributed to the broad market gains, and some are tied to the buyback and dividends being raised.

This does not feel like a home run on the dividend hike, but when you add in that the company is buying back more stock it may look a bit better. The real issue is that Costco just may not be able to handily buy back much more stock unless the market corrects its shares lower and the company wants to do something about it. It may be cheaper for Costco to acquire new properties for growth rather than to buy back stock and send all of its cash out the door to shareholders.

ALSO READ: Why Groupon Is Already Returning Capital to Shareholders

 

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