Costco's Canadian Success Story

| About: Costco Wholesale (COST)
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Summary

Costco now sells twice as much food in Canada as Wal-Mart does. Costco sold $8.9 billion worth of food in Canada in 2013; Wal-Mart sold $4.5 billion.

Costco is now Canada’s fourth largest grocer behind Loblaw, Empire, and Metro.

Costco now has around 10 million members in Canada. Given that the population of Canada was 35 million in 2013, that means nearly one in three Canadians is a Costco member.

Costco Canada’s revenue was $13 billion in 2013. Since Costco’s total revenue was $112.64 billion on August 31, 2014, that means Canada accounts for nearly 10% of Costco’s total revenue.

Canada is a very difficult environment for American retailers as both Target (NYSE: TGT) and Wal-Mart Stores Inc. (NYSE: WMT) have discovered in recent years. Yet, there's one U.S. retailer that has been doing incredibly well in Canada - Costco Wholesale (NASDAQ: COST).

Costco operates just 88 stores in Canada, yet its revenue in the country exceeded $13 billion in 2013, according to Canadian Grocer. What's even more astounding is that Costco has around 10 million members in Canada - a nation of around 35 million people. Those numbers seem to verify Jesse Bellet's estimate that Costco's sales per square foot is around $1,156. In contrast, Wal-Mart and its Sam's Club subsidiary have sales of $400 to $680 a square foot according to Huffington Post contributor Jennifer Berman.

Costco Beating Wal-Mart in Canadian Grocery War

Costco is so successful north of the border that it is transforming the Canadian retail landscape. Global News writer Jamie Sturgeon proclaimed Costco the winner in Canada's increasingly bloody grocery wars. Data from financial firm Raymond indicates that Costco's share of the Canadian grocery market increased by 53% between 2008 and 2013.

The club store operator is now the fourth largest grocer in Canada behind traditional supermarket operators Loblaw Companies (TSE-L) (OTCPK:LBLCF), Empire (Operator of Safeway and Sobeys Stores), and Metro Inc. (TSE: MRU). Wal-Mart is the fifth largest grocer in Canada. Costco's food sales were actually more than twice those of Wal-Mart's in Canada.

Canadians bought $8.9 billion worth of food at Costco and $4.5 billion worth of food at Wal-Mart in 2013. Since Canadians spent $108 billion on groceries in 2013, that gives Costco a large share of the nation's grocery market.

The grocery war has badly mauled Wal-Mart, which announced on November 18 it will lay off 210 employees in Canada in a cost-cutting move. The layoff came a week after Wal-Mart reported that traffic at its Canadian stores fell by 1.4% in the third quarter of 2014. That was only the latest round of layoffs at Walmart Canada, which eliminated 700 store manager jobs in May.

To increase business, Wal-Mart has spent around $0.5 billion to add food at most of its Canadian stores. Wal-Mart currently operates around 390 stores in Canada. Nor is Wal-Mart the only retailer hurt by Costco's explosive Canadian growth; Loblaw saw its sales decline by 5% between 2008 and 2012.

Why Is Costco So Successful in Canada?

So what's behind Costco's Canadian success, and can it be replicated elsewhere? The first and most important ingredient in Costco's recipe for Canadian profits is plain old fashioned experience. Costco has been operating in Canada since 1985; Wal-Mart has only operated in Canada since 1994; Target just arrived in Canada in 2013. Costco has almost 30 years of experience in Canada.

The experience gives it an edge because Costco knows Canadians well and understands the fundamental differences between Canadian and American retail. The biggest of these differences is that Canadians tend to be value shoppers seeking the lowest price or the best deal rather than particular brands.

One reason why Canadians are value shoppers is that their economy has historically been more unstable than the U.S.'s. Canada is more dependent on natural resources and commodities prices. It is also more vulnerable to inflation because the Canadian dollar is a weaker currency than the U.S. dollar. That makes Canadian shoppers more price conscious than Americans. Canadians have also historically had less disposable income than Americans, which also makes shoppers more sensitive to prices.

Costco with its large batches at low prices appeals to those sensibilities. That might also explain Costco's success in the United States in recent years. The U.S. economy has gotten more like Canada's because the average household income has been falling in recent years. It is now around $52,000 compared to $57,000 in 1999, according to ValueWalk's Gary D. Halbert. Americans have less to spend, so like Canadians they seek more "bang for their buck" when they shop.

Another reason for Costco's success in Canada is lack of competition. Wal-Mart pulled the plug on Sam's Club Canada in 2009 after operating just six stores for three years. Wal-Mart ended the Sam's Club experiment in Canada because of an inability to compete with Costco.

Costco Tries to Repeat Canadian Success Down Under

Now for the $1 billion question: Can Costco duplicate its Canadian success in other countries? The answer is yes if it expands to mostly middle class, English-speaking countries. Costco seems to be duplicating its Canadian triumph in another country that's a lot like Canada: Australia.

Costco reported $660 million in sales in Australia in 2013 with just five locations in three cities, Melbourne, Sydney, and Canberra, Costco's Australian chief Patrick Noone told The Australian. Costco has only been in Australia since 2009. It just opened its sixth and seventh store Down Under in Brisbane and Adelaide this year. Noone told The Australian that Costco is aiming for $1 billion in sales in Australia in its next fiscal year.

The Canadian success demonstrates that Costco might just have the perfect business model for 21st Century retail with its large sizes, low prices, and memberships. What's even more exciting is that business model seems to be transferable to other countries.

That, of course, points to an interesting question for retail investors: Are the traditional discount store and grocery store retail business models obsolete? Costco's success seems to indicate they are, which could be very bad news for companies like Wal-Mart and Target.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.