Costco CFO says China has huge potential as he gives us a peek at international expansion plans

Published Tue, Jan 30 20247:20 AM ESTUpdated Tue, Jan 30 202410:38 AM EST

The world's second-largest economy has "very good potential" for Costco expansion, CFO Rich Galanti told CNBC. Perhaps, that's even an understatement, if the mob scene outside the recent opening of the first Costco in Shenzhen is any indication. Six warehouse stores in all of mainland China do not seem to be anywhere close to being enough. In an interview with Galanti, the warehouse club's numbers cruncher gave CNBC a glimpse at Costco's longer-term expansion plans. "We'd probably be at least fifty-fifty outside of the U.S. and Canada" in the next six to seven years, he said. Costco is "not saturated" domestically or internationally, he stressed. Most of Costco's 873 locations , as of Monday, are in North America: more than 68% in the United States, 12% in Canada, and 4.5% in Mexico. The rest of the stores are on every continent except South America. Costco pointed us to its new locations page and said planned new store openings are usually announced two to three months in advance. As of Monday, there were no South American locations on the docket. Costco plans to open one more China location this calendar year after the debut earlier this month of the store in the southern Chinese city of Shenzhen. Part of the reason why the company has seen so much success around the world is its deep value proposition, a fundamental reason why the Investing Club is in the stock. "We bring great value and great products given our global size and people like big stuff at great prices," Galanti said. To be sure, Costco has traditionally been cautious about international expansion. Craig Jelinek, who retired as CEO at the end of last year, told Jim Cramer in December : "We've been successful in every country that we've done business in, and we feel that we will continue to do so. To the extent that we can do business in other countries, we will continue to grow our international business." That wasn't exactly a rousing call to action. Perhaps, Jelinek didn't want to box in new CEO Ron Vachris, the longtime Costco executive who took the reins on Jan. 1. Either way, the sign-up numbers in China are staggering. Typically, new member signups at U.S. locations within the first year range between 50,000 to 60,000. In China, the first Costco in Shanghai, which opened in 2019, had 200,000 members rather quickly and over about four years expanded to 400,000. Earlier this month, those crowds at the Shenzhen opening were so big, the lines wrapped around and around and looked more like people waiting for a Disney ride during spring break. Wall Street is bullish on what Costco could be in China, which represents the company's "biggest growth route," Phillip Blee, analyst at William Blair, told CNBC. Part of the reason for this is a higher tier of membership mix in non-U.S. locations is less prevalent. In the U.S., a lot of members choose the Executive membership which costs more, but this is "still a nascent offering internationally," Blee explained. In China, for example, Costco still has a single membership offering. Blee called out a tiered membership offering as an "opportunity of growth to mature their customer base to more resemble U.S. stats, like high renewal rates." Costco has 129.5 million total member cardholders, as of late November, with a 92% renewal rate in the U.S. and Canada. Costco typically offers the Executive membership in markets where there are at least 15 locations. To expand membership types, "we need a core number of locations in a market and a core base of members to be able to offer not only the typical 10% reward that's associated with the executive membership but other services or savings that comes with it," Galanti said. This eventual skew toward international openings will help Costco's profitability, according to Corey Tarlowe, an analyst at Jefferies. That's because it costs the company more to pay employees in the U.S. "Costco is one of the premium wage payers in terms of dollars per hour it offers and benefits and leads the market in this regard in retail," Tarlowe said. "Internationally, it's slightly less expensive in terms of wages and benefits it offers employees, and that benefits the overall profit margins." Michael Baker, analyst at D.A. Davidson, also sees a "long runway for growth in international markets for Costco." Costco's international segment "continues to grow as a percent of the store base," he told CNBC. This year alone, he said, roughly 30% of the new stores are planned for "other international," excluding Canada. "To the extent they can keep opening up international clubs with big numbers, that ends up being a catalyst," he added. Another piece is the growth of Kirkland Signature, Costco's private label brand. Right now, Blee explained that Kirkland "isn't as big of a draw internationally," when compared to the U.S. where it has widespread brand recognition and appeal. That could change as Costco expands its non-U.S. locations. Costco tends to be successful in the markets it operates in — but more broadly, in both domestic and international markets, Tarlowe believes Costco could be impacted by potential deflation. That's when the prices for goods that consumers pay are lower. "We've seen deflation in some categories like dairy, fish, certain fruits and vegetables — and inherently, when the cost of your goods is lower but wages are still up, it tends to lead to slimmer margins," Tarlowe said. Still, he called this a more "muted" risk for Costco, which benefitted from inflation over the past couple years even as the company tries to keep its prices lower. It would also bode well for Costco members who would benefit from extra savings. Bottom line While China and other international expansions are gravy, we own Costco as a U.S. defensive play as value-seeking consumers prefer Costco's membership model that offers cost-saving deals in an uncertain economy. We got one of the two major catalysts we've been waiting for in the stock — a special dividend. The other is a membership fee hike, which is way overdue. Costco shares hit a new all-time high of just under $700 each on Jan. 22, topping our Club price target of $680 per share. However, the stock has pulled back roughly $10 since then. Over the past 12 months, Costco has gained roughly 37% COST 1Y mountain Costco 1 year Costco is scheduled to report its sales for January on Feb. 7, according to FactSet. Unlike most companies, Costco puts out monthly numbers, which gives investors like us a real-time scorecard on business. The company is set to deliver its fiscal 2024 second-quarter earnings on March 7. In fiscal Q1 , Costco grew and beat estimates on earnings per share and revenue. At the time, we wrote, "The results further demonstrated how the company shines in a challenging macroeconomic environment, with many other retailers under pressure from a weakening consumer, bloated inventory levels and theft." (Jim Cramer's Charitable Trust is long COST. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . 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Shoppers queue in the parking lot to enter the Costco Wholesale Corp. store in Shenzhen, China, on Sunday, Jan. 14, 2024.

Qilal Shen | Bloomberg | Getty Images