Costco Wholesale Corp. (COST) is a hot topic and stock market darling. Despite its slight loss since the beginning of the year, the stock is still up 15% year over year. What makes Costco so appealing to investors? Is it the cult-like following that draws customers in? The rarely seen business model? The lack of pricey decor or customer comfort?
The real answer lies in Costco’s growth potential. With 663 stores, 13 of which were opened in 2014, the company is showing that it’s dedicated to increasing membership. As all of Costco’s profit is derived from membership, increasing store count and membership numbers leads to increased profit for its shareholders. (For more, see: Is There Any Upside Left In Costco?)
Costco in Pounds and Pesos
Costco abroad is like McDonald's Corp. (MCD) abroad: everything looks the same but there are added local products. Costco has seen its sales figures from abroad increase by 8% in 2014 (compared to 7% in America) and by 3% when comparing same store sales. Membership renewal rates abroad are not as high as in America but are still a healthy 87%.
When traveling or living abroad, finding food from home can be difficult. Since Costco carries the same products in all of its stores internationally, expats flock to the warehouses to pick-up sorely missed bacon or candy bars from home. Additionally, locals will head to Costco to pick up American food staples out of curiosity or because Costco has consistently low prices when compared to competitor stores.
It’s no surprise then that Costco’s fastest growing markets are Australia and Asia. The cost of living in Australia is astronomical and getting anything shipped from America can get prohibitively expensive. By shopping at Costco, Australians are able to get low-priced groceries and goods from abroad. In Asia, eating western food is a status symbol. In other words, going to American chain restaurants and buying American snacks is reserved for the status conscious. It makes sense then that Costco is growing in Asia – access to low-priced, bulk quantities food mean that restaurants and customers can buy the ingredients necessary to eat American cuisine.
Of Costco’s three main competitors only Wal-Mart Inc. (WMT) is a serious competitor abroad. Sam’s Club has a smattering of stores in Brazil and in China, while BJ’S Wholesale Club only operates in America. (For more, see: Business Model Analysis: Costco Vs. Sam's Club.)
Let’s examine Canada since it’s Costco’s largest international operation. In Canada, Wal-Mart operates only 282 superstores across the country (Costco has 88 stores). These stores are great for day-to-day purchases, but when looking for bulk buys and low prices, people don’t think Wal-Mart they think Wholesale Club (L.TO). That being said, the lack of general merchandise and few locations make Wholesale Club a lackluster competitor. Plus, without membership fees to boost revenue, the stores’ margins and prices are higher than at Costco.
The lack of competitors is a great example of why Costco is able to expand its operations in Canada year after year. This strategy is something that Costco needs to emulate in other international markets to increase its revenues and profits.
Diversification is Key
Currently, Costco is a two-country pony. 87% of its 2014 sales came from American and Canadian stores. With the Canadian dollar falling against the American dollar, Costco cannot afford to have a significant chunk of its revenue come from Canada. If the company can increase the revenue from abroad by opening new stores, it can hedge itself against currency fluctuations.
Here’s another example. For a brief period in 2007, the Canadian dollar was worth more than the American dollar. For Costco, this was wonderful – prices could remain constant in Canada and the customers would continue to pay X amount for a 20 pound package of bacon. When the X amount was converted to American dollars, instead of Costco receiving the X-15% that they had forecast before the US dollar depreciated, they received X+5%. Soon though, the situation reversed. The Canadian dollar fell sharply and Costco started to receive X-20% for the bacon for which they had forecast receiving X-15%.
For a company like Wal-Mart, currency fluctuations are a nuisance that must be accepted as part of business. For Costco, currency fluctuations can be deadly. The company operates on razor-thin margins and a currency devaluation of even 5% can be the difference between profit and loss. It is because of the danger of currency fluctuations that Costco needs to diversify its income. Selling products in only one country isn’t a problem but selling products in two countries leaves a company open to a huge potential for loss from a currency devaluation.
The Bottom Line
Costco’s future lies in foreign hands. The company has spread across America and now needs to look for new markets in which to do business. With the company heavily exposed to the Canadian market, it needs to continue expanding in Australia, Asia and Europe. By diversifying its revenues and entering markets that have little existing competition, Costco will grow stronger and its shareholders will be increasingly happy as they see profits rise year after year.