Costco Has Room For Growth In Mexico

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Costco (NASDAQ:COST) is the largest warehouse retailer in the U.S. with over 530 stores in North America and around 100 stores in international markets such as Mexico, the U.K., Japan, Taiwan, Korea and Australia. In terms of store count, Mexico is the third most important market for the company with 33 stores operational at the end of September 2013. Costco started its operations in Mexico through a 50% owned joint venture, and its store count had been stagnant for the past four-five years. However, the warehouse retailer acquired the remaining 50% stake from its partner last year and has opened one store since. Costco plans to add another store in the current quarter and we expect it to continue expanding in Mexico in the future. The retailer has seen robust comparable store sales growth in its Mexican operations and the region's retail market holds tremendous potential. [1]

Mexico is the second largest economy in Latin America and the 11th most populous country in the world. Over the past few years, Mexico has seen strong growth in its retail industry with a stable economic environment, controlled inflation and increase in credit facilities. The market potential is clearly visible from the fact that the retail giant Wal-Mart (WMT) operates close to 2,500 stores in the region. Although the economic growth has suffered in the recent past, lower interest rates and diluted tax reform should have a positive impact on consumer confidence going forward. Even the prevailing economic weakness bodes well for Costco's growth since the retailer provides its customers with a valuable cost saving shopping option.

Our price estimate for Costco stands at around $125, implying a premium of about 5% to the market price.

Mexican Retail Market Holds Good Potential

Historically, Mexico's retail industry has remained strong as the region has sustained its economic growth and kept inflation under control. What's promising is that the retail market growth exceeded the country's GDP growth last year. [2]

Financing and consumer credits have emerged as important retailing tools in Mexico. Several retailers are evolving into financing bodies by providing the options of deferred payments at a cash price. "Meses sin intereses" or monthly payments with no interest has become a common practice in the market. Moreover, as the competition is rising and consumer demands are increasing, a number of department stores and grocery retailers are expanding their product portfolio. Since Costco already offers a wide variety of products, it is likely to benefit from this trend.

The retailers are also looking to expand throughout the country while specifically targeting regions with heavy footfall, which has bolstered the popularity of smaller format and quick-stop stores. [2] This might prove to be a roadblock for Costco's expansion since its stores are usually large in size (140 k). However, Costco relies less on the convenient location of its store (unlike Wal-Mart Express and Target's (TGT) CityTarget stores) and more on its business model to attract customers. Moreover, with rising competition a number of Mexican retailers are switching to Internet retailing. In response to this trend, Costco plans to launch an exclusive e-commerce website for Mexico this fall. [1]

Current State Of Mexican Economy Might Favor Costco's Growth

Although Mexico's retail sales have grown in the last few years, they declined unexpectedly during the initial period of 2013. [3] [4] This is attributable to weak consumer confidence and a slowdown in the overall economy. Mexico's economy shrank by 0.74% in the second quarter due to lower government spending, weak demand for exports and sluggish consumption. This marked the first decline in the country's economy in the last four years. [5]

Mexico's strong ties with the U.S. economy seem to be preventing it from enjoying strong economic growth that its emerging market peers such as Brazil have. [5] Due to weakness in the economy, the largest retailer in the region Walmex (Wal-Mart Mexico) witnessed sales declines in consecutive months of July and August. Comparable store sales for other Mexican retailers also fell by 2.3% in July. [6] However, policy makers are likely to cut interest rates in order to stabilize the economic growth. [4] Also, the Mexican government did not include sales tax on essential items such as food and medicine in the latest tax reforms. [6] This should positively impact consumer spending on groceries, which will assist Costco's growth since it earns more than 50% of its revenues from this category. Even the weak economic environment bodes well for Costco's growth as it serves as a viable shopping destination for buyers looking to save money. This is evident from the fact that Costco's sales have remained resilient in the U.S. despite the retail market slump arising from cautious consumer spending.

Disclosure: No positions.

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