Costco's (NASDAQ:COST) business is on a tear right now. The warehouse retailer just posted an industry-thumping 8% jump in comparable-store sales for the first half of fiscal 2015.
Its operating strategy continues to work like a charm. Costco earns high satisfaction scores from its customers, which powers record membership renewal rates. And that success helps it win market share from rivals such as Wal-Mart and Target.
But with the business setting new all-time highs, it's easy for investors to ignore hefty threats to this retailer. With that in mind, let's look at one risk that Costco's management believes is particularly important for shareholders to understand.
Here's how Costco describes the concern all the way at the top of the section titled "Business and Operating Risks" in its latest annual report: "We are highly dependent on our California operations."
Costco operates about 700 warehouses around the world, including in huge international economies such as Japan, the United Kingdom, and Mexico. But more than 70% of its sales come from the United States. And within the U.S. a whopping 32% of Costco's revenue is generated in California.
The Golden State has "a larger percentage of higher volume warehouses as compared to our other domestic markets," Costco warned. That's important because "any substantial slowing in these operations" would have an outsized effect on the company's overall results. In other words, Costco is heavily exposed to the strength -- or weakness -- of the California market.
A big driver behind that concentration risk is simply the sheer size of the state's economy. California's GDP is over $2 trillion per year, which makes it easily the biggest market in the United States. In fact, California's economy would rank as the seventh largest in the world, ahead of Brazil's and Russia's, if it were a stand-alone nation. It's only natural for a market that big to account for a large portion of any national retailer's sales. Still, Wal-Mart, Target, and Kroger don't list California as a major concentration risk, which suggests Costco is more heavily exposed to that state than are its rivals.
It's important to note that Costco's California business will usually rise and fall along with the rest of the country. In most cases, the warehouser wouldn't have a major issue in that state that isn't also affecting its results in other markets. But California does have a few specific risks specific. For example, think natural disasters like earthquakes, or climate sensitivities like the four-year drought that has recently put the state on mandatory water restrictions.
Keep an eye on it
None of this is to say that shareholders should lose sleep over this geographical concentration risk. Costco is simply succeeding in an area of the country that has grown rapidly. But Costco's California dependence is something to keep in mind as you consider the retailer's overall business results.
The California economy is thriving right now as the population spikes higher and businesses pour resources into the state. Costco has done a great job at capturing sales gains from that boom. But the flip side to that success is that the retailer could be hurt if the state's economic growth falters.
Demitrios Kalogeropoulos owns shares of Costco Wholesale. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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