Costco Wholesale Corporation (NASDAQ: COST) is a membership-only warehouse retailer that provides a wide variety of merchandise. It is based in the United States, and in 2014, was the third largest retailer in the country. In 2015, it jumped to the number two spot behind Wal-Mart Stores, Inc.
Costco, even with its large size, is not known for paying a high dividend. The warehouse retailer will pay a total dividend of roughly $1.60 per share in 2015, which equals a dividend yield of 1.2%. This is the lowest dividend yield when compared to other national retailers such as Home Depot, Inc., Target Corporation and Wal-Mart. Wal-Mart pays the highest dividend out of this group with a yield over 2.5%.
However, there is more to Costco's dividend strategy than payment of its regular dividends. As of 2015, the company paid two special dividends to investors over the past three years. These special dividends were comprised of a $5 payout per share in 2015 and a $7 payout per share in 2012. Combining these special dividends with Costco's average dividend payout gives investors an effective dividend yield of 5% over the last three years.
Special dividends cannot be counted on every year to affect payouts. Instead, investors should look at Costco's payout ratio, cash flow and expansion commitments as indicators as to what will happen to the company's dividend payments in the future.
Costco has a 40-cent quarterly dividend per share in 2015, which equals $700 million in total dividend payments for the year. This is roughly a third of the company's year-end profits in 2014, meaning its current payout ratio is effectively 33%. To compare, both Wal-Mart and Home Depot have payout ratios closer to 50%.
While Costco's low dividend payout ratio might be a concern for some investors, it provides an opportunity to increase its payout ratio. Most of the company's annual profits come from its annual membership fees, which is in contrast to other national retailers that use sales markups to drive profits. Membership fees are less volatile than sales markups, and Costco can confidently increase dividend payouts due to stable profits.
Costco is known for having a strong cash position. Its operating cash flow reached $4 billion in 2014, an increase of 18% when compared to 2013. This free cash flow is a sign Costco can comfortably increase dividend payments. In fact, Costco's dividend payout ratio has increased in lockstep with increases in its operating cash flow. The company's cash flow has more than doubled since 2009, and over that same period, Costco's quarterly dividend increased from 20 cents to 40 cents. Operating cash flow is expected to increase even further by year-end 2015, and management has responded by raising the dividend yield by 14% in 2015 alone.
The company also has an aggressive share repurchase program that takes away from the operating cash flow that can be used to increase dividends. In Q1 of 2015, Costco repurchased shares worth roughly $18 million.
While Costco's low payout ratio and cash flow support potential dividend yield increases over the long term, the company's expansion strategy works to reduce the chance for any increase. Costco also uses its operating cash flow to purchase additional land, buildings and warehouses. It is believed management prioritizes these investments over dividend payouts.
For example, Costco is continuously purchasing and opening large stores; it spent $2 billion on new store warehouses in 2014. Senior management has plans to invest more than $2.5 billion on capital investments in 2015. These investments reduce the amount of cash Costco has available to pay to shareholders. A good sign for income investors is Costco's expansion plans are relatively small. The company opens roughly 30 new stores each year, which results in less than a 5% growth in annual locations.