In 2020, RBC released a research paper estimating COST could grow its US store base by over 400 units. The population size, density, and median income of many regions of the US are still under-penetrated by Costco. At the 15 year average of ~13 US stores added per year, this gives COST another ~30-years of growth. 

This is arguably the larger opportunity and it’s proving to be more profitable on an EBIT basis. 

We recently published two interviews with former Costco executives, who each spent over 30 years at COST, to discuss the international growth opportunity. One of the executives was responsible for scouting new markets, opening multiple APAC countries and more recently worked for Sam's in China. 

The major takeaway is that Costco has an incredible international opportunity, especially in China. 

In this analysis, we explore the potential store count ex-US over the next 20 years and analyse why international EBIT margins are structurally higher than the US. 

Costco is very conservative by nature. It took the management over 20 years to finally enter China:

China took over 20 years to open, working with the government, assessing the economic health landscape; all the things that go in with starting a business. They are not starting from scratch because they already have a template in the US and Canada that works well, that has been wear tested for over 40 years. - Former Senior Manager at Costco for 30-years

Sam’s entered China in 1996 and now has ~40 clubs with >3m members. But Sam’s China is very different from the US. Costco’s Chinese stores offer ~40-50% local products whereas Sam’s is closer to 90%. Walmart also flies expats to China to open clubs before replacing them with locals. Over time, the clubs lose the allure of an American brand and begin to feel like a typical Chinese hypermarket. 

I opened Korea in 1994, and Walmart came in about the same time, and I thought, wow, they're going to be very successful here, and they're going to knock these guys around, and they didn't. Over the years, I’ve watched this phenomenon constantly and dealt with it in China because I worked with Walmart there. Walmart opens with a team of expats; they get the program up and going, and then, to reduce costs, they throw many of the expats out and use local teams to run the business. All of a sudden, your Walmart starts looking like any hypermarket in China because that's what the local guys know. That's what happened in Korea. They ended up being nothing special. They weren't different. They did the same thing in China. - Former Director, Costco APAC

A brief, somewhat large caveat: any forecast of Chinese store growth assumes a Chinese government that plays nice with Costco. This is hard to handicap. But the former COST executive with over 25 years experience in APAC has an interesting take on why China's government will be rebooting growth after Xi wins another term:

The weakness of the government there is that, if you think back in history, can you ever remember when the Chinese government came out and said we were wrong about something? Never. Because they think that's weak. This country was founded on civil war and an uprising of the people. With 1.6 billion people, the Chinese government is afraid of its own people. The US isn't their biggest threat; it's their own people. If they get angry and want to make a change, they're in trouble because you can't control that population. They keep a tight rein on things because of that mentality. But they're not stupid, they're very smart, and they know they have to get their economy fired back up because without that, they can't achieve everything they want to achieve both economically and militarily and have the money to pay for all that. - Former Director, Costco APAC 

For the sake of our analysis, let’s assume China is fully open to Costco. The executive believes COST can open ~400 stores in APAC and ~150 in China in the next decade. 

In China, once this pandemic is out of the way and China’s economy gets back to anywhere near normal, there’s a tremendous amount of growth potential for Costco. It's huge. Even with that being the one market in Asia with a solid competitor in Sam’s Club, the population density is so heavy in those markets, Shanghai, and all these Tier 1 cities; these guys can be a few kilometers away from each other and have no impact. The ability to grow is huge. In Korea, for example, when I opened one club in the 1990’s, the thing shot up, and within three years, it was a $400 million club in 150,000 square feet. We kept opening clubs close by to take pressure off, and the sales would drop a few percentage points and go back up with no impact. You will see real growth in the future for Costco. If you're looking at the total potential within the [APAC] marketplace, you could see 300 or 400 clubs in the next 10 years if they really wanted to do it. - Former Director, Costco APAC 

So how many international stores could Costco realistically open in the next 20 years?

RBC use five major factors to estimate new store openings:

Accuracy is difficult without having the specific location of each COST store to calculate population density and competition by market. However, we can make a rough estimate based on public information of two different countries: Canada and the UK. 

At a group level, Costco generates $227bn in revenue from 66m paid members or 119m total cardholders. This equates to $3,439 annually per paid per member. If we assume the average Canadian paid member spends this amount per year, Canada has ~9.2m members and 24% penetration. 

This penetration rate seems high but feels directionally correct given the comment below from an interview we hosted with a former executive of 26 years at COST Canada:

The last number I saw years ago when the population base in Canada was 34 million people, 6 or 7 million people had a Costco card, which is phenomenal when you think of how many areas don't have a Costco. Half of the population base doesn't have one, so it was incredible, and I'm sure it's gone up since then. - Former Senior Buyer, Costco Canada

Canada’s high membership penetration is due to a 38 year operating history and a lack of competition. 

The UK is a slightly different story. In FY21, Costco generated £3.35bn revenue from an estimated 2m members. This is a ~3% membership penetration and ~50% lower annual spend per member than US or Canada. 

It’s unclear exactly why UK member penetration is so low. It’s likely due to more competition. Aldi and Lidl both have ~1,000 stores and have been taking market share from the big 4 by offering ultra-low prices with higher quality produce. It’s more difficult for COST to win share when there are thousands of quality, grocery discount stores around. 

There is also simply less space for 150k sqft locations on our little island. COST is great for bulk buying and storing products. This requires space in the household. In London and other dense cities, COST will not only struggle for space but also customers don’t have room to store as much product. 

Canada and the UK are arguably on two different ends of Costco’s performance. Both countries have very different population densities, GDP, and store counts. Canada has 107 stores in a country with $1.8 trillion in GDP, $17bn GDP per store, and the UK has only 29 stores or £74bn GDP per store. GDP per capita per store is double in the UK vs Canada. 

Canada is still slowly growing. The UK hasn't added a unit in 5 years. Both are mature, saturated markets that we can use to forecast the potential store count in other international countries. 

We assume each store attracts customers from a 10-mile radius, a 10-20 minute drive from the store. An old flyer listing Costco’s site criteria confirms the population target per store in North America. As we can see below, the minimum population density per square mile is 6.41x higher in the UK than Canada due to higher competition / lower membership rates and population density.  

By estimating the GDP per capita per store for other countries, we believe COST can add ~650 international stores excluding Southeast Asia, Caribbean, and large parts of Europe. 

We believe Costco can open up to 300 stores in China over the next~20 years. Its first store in Minhang, the Shanghai district, has a population of ~2.65m. A year after opening, the store had ~400,000 members. Granted, this was the first store in the country, but the global average is ~70,000 members per store. 

California, COST's largest market with 23% of its US store base, has a per capita density of $641. Shanghai has 27m people with half the GDP per capita as California, but 20x the density per square mile. At $1,000 per capita per store, a similar density as the UK, Shanghai alone could have ~40 stores. These are just rough estimates so feel free to edit any per capita metrics based on market competition. 

We’ve excluded any growth from Southern Europe because it seems the government’s are hesitant to let an iconic American brand shape its community and put local mom-and-pops out of business:

The biggest challenge in those countries is government rules restricting size limits on retail facilities…Still, the biggest challenge is government restrictions, fighting against behemoths like Costco, and having it affect the small mom-and-pop businesses you see in Italy and France. That's a big part of their economy, it's very protected, and it slows the development down in those countries. - Former Director, Costco APAC 

We’ve also excluded Southeast Asian countries like Vietnam and have been conservative on Australia which has the potential for as many stores as Canada. 

Overall, we believe COST can open a minimum of ~650 stores internationally. If we assume COST continues to open ~20-25 stores per year globally, this provides 40-years of unit growth, ~2% CAGR. 

The combination of unit growth and sales per sqft powers COST's revenue growth. A solid 2% unit growth plus a long-tail of maturing stores will power high single-digit revenue growth for decades to come. 

And margins are also higher abroad for structural reasons. In the US, the executive estimates ~30% of labour cost which isn’t paid in other countries. 

[US healthcare employee cost] runs between 40% and 30% depending on certain areas, but yes, it is about a third of their cost, and it's a big hit. It's a huge hit. In Asia, we didn't have to deal with it that much. In each country, there's a cost for national healthcare. In some countries like Taiwan and Japan, the company pays a third of that cost, but that cost is fractional compared to the US. The US has a huge hit, and it's not a big hit against the company in Asia. In China, there isn't any hit; the Chinese government provides everything. - Former Director, Costco APAC 

It’s also incredibly impressive how such a business at scale can continue deploying capital at high returns. COST’s ROIIC has increased over the last 5 years to 40%. 

As greater volume flows through each US store and more higher-margin, less capital intensive international stores open, returns may stay higher for longer than expected. The 5-year rolling ROIIC has been steadily increasing over the last 15 years.

Overall, we don’t need to explain why COST is a phenomenal business. The question is more: can management maintain the culture and execute abroad?

The model is replicable, but every market is slightly different. And there are signs of Jelinek slightly tweaking Sinegal’s philosophy. One thing we can also be sure of, is COST being very conservative on any international growth estimates. 

If you look at Costco's numbers, you can bet they're tremendously conservative every time. That's just their nature. We had to continuously adjust our parameters as we learned lessons in Asia. A good example is, we went into Korea and expected to be at close to eight clubs, and they will end up with double that. In Taiwan, it's the same. In Japan, we thought maybe 20 clubs, and we were there in a matter of years. We had to keep adjusting that because we always went in very conservatively. - Former Director, Costco APAC 

These are our very rough back of envelope numbers and no decade-long forecast should be taken at face value. Clearly there are many local intricacies and execution risks to taking COST’s model abroad. Please reach out if we’re missing anything that could help refine the forecast.

Costco International: 650+ Store Opportunity

In Practise Analysis

inpractise.com/articles/costco-international-store-count-outlook

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