Costco: Revenue Growth Concerns

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About: Costco Wholesale Corporation (COST), Includes: AMZN, WMT
by: Will Healy
Summary

Costco's dividend announcement offered hope to investors.

Costco has been experiencing the slowest revenue growth since the financial crisis.

A recent membership price increase and the potential for domestic and international expansion offer hope for further revenue growth.

Momentum has returned to Costco (COST). The stock declared a $0.50/share dividend on July 31, sending the stock's value up by $7 in only two days. Having lost approximately 20% of its value after Amazon (AMZN) announced its acquisition of Whole Foods (WFM) in June, the dividend represents the first financially-based indication of strength since the stock price fell. While investors seem less worried that Amazon will put Costco out of the grocery business, Amazon's competitive threat has still affected Costco regarding revenue growth. With slowing revenue growth and signs of saturation beginning to take hold in its home market of the United States, investors need to know if there's revenue growth potential left for the warehouse retailer.

With some bright spots on Costco's balance sheet remaining, it can certainly be argued that the negative reaction to the Amazon/Whole Foods threat was overdone. In addition to the recent dividend announcement, Costco's compound annual growth rate (OTCPK:CAGR) of 7.2% is still outpacing most of its competitors, an impressive feat considering that Costco sells its merchandise for little more than the cost of goods sold plus overhead. The key metric of concern is revenue growth. Revenue growth slowed to 2.2% in fiscal 2016, its lowest growth reading since 2009, a year when the world was in the midst of a financial crisis.

Even when one does not consider Amazon's competitive threat, the company is already operating in 44 U.S. states and 9 Canadian provinces. Costco now operates in most of the largest metropolitan areas in these respective countries. Hence, domestic opportunities to expand the customer base beyond population growth are going to be limited to smaller metros. Within the U.S., many metro areas between 250,000 and 1 million in population do not currently have a Costco warehouse. These areas remain untapped markets for growth. For Cities as varied as Corpus Christi, Oklahoma City, and Buffalo have yet to welcome a Costco to their area, so domestic opportunity remains. Additionally, Costco's membership fee, its primary source of profit, was recently increased to $60. Assuming Costco's renewal rate avoids a dramatic reduction, this increase will be a further shot in the arm for Costco's revenue growth.

Expanding internationally could be a different matter. Costco has embarked on an aggressive expansion beyond North America and has already opened over 100 stores across Europe, East Asia, and Australia, as well as 38 stores in Mexico. The challenges will be making sure Costco doesn't fall victim to the same cultural challenges that befell Wal-Mart (WMT) and other older U.S. retailers. Although accommodating customers who generally live in apartments and condos has been a concern, Costco's international strategy appears to be succeeding. Membership renewals stand at above 80% for its non-U.S. operations. Additionally, its CAGR internationally has exceeded that of its domestic market, growing at 11.7% over the last five years. However, Costco faces the same currency risks that affect its U.S.-based competitors. In the first half of 2015, while its international same-store sales grew at 7%, currency fluctuations took that growth rate to just 3%.

Despite worries over slowing revenue growth and competition from Amazon, Costco's growth story still has a long way to go. Despite competitive pressures, the company is maintaining strong growth rates overall. And with a strategy for expanding internationally that has so far been successful, Costco is showing that they can compete outside of North America where other American retailers have failed. With a recent membership price increase and expansion opportunity both at home and abroad, most of Costco's growth potential looks to be untapped.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.