Costco Wholesale Corporation (NASDAQ:COST) rewarded shareholders in 2015 with its stock climbing more than 19% compared to a less than 1% gain in the S&P 500 index year to date. That noteworthy performance came on the heels of strong free cash flow, special dividends, and market-share gains. However, the question on many investors' minds now is what the year ahead holds for the wholesale giant.
A wide competitive moat
Costco should continue to win in 2016 thanks to its wide moat and strong membership generation. The wholesale retail chain is also well positioned to increase its membership fee -- a move that would further boost reoccurring revenue for the retailer.
Selling bulk quantities of merchandise allows Costco to pass cost savings on to customers. That, in turn, fuels customer loyalty, and helps attract new consumers to its membership model. This is particularly important for Costco, considering that revenue from the membership fees it charges account for about 70% of the company's operating income.
Costco currently charges an annual membership fee of either $55 for its business or Gold Star memberships, and $110 for their Executive membership, which includes 2% cash back annually on most Costco purchases. The wholesaler has historically raised its membership rates every five years or so, with its most recent bump in price happening in 2011. It therefore seems that Costco is due for another price increase in 2016.
This will undoubtedly be good for business, as membership fees generate the bulk of Costco's profits. It could also inspire existing members to visit Costco's warehouses more frequently in 2016 as a way of taking full advantage of their annual memberships.
In addition to expanding in the U.S., Costco also plans to grow operations overseas in the year ahead. Management says it will open 32 net new warehouses in 2016, with 18 to 20 located in the U.S., and the remainder of these internationally. The retailer currently has a strong and growing network of locations in Canada, Australia, and Japan. Nevertheless, it plans to kick off the New Year by opening its second warehouse store in Spain, and its first in France. Both of these markets could contribute to sales growth down the road as Costco builds out its brand in the regions.
Canada is currently Costco's largest market outside of the U.S., accounting for more than half of its total international sales. However, that could change as Costco adds new locations in lucrative markets such Spain.
Costco's international stores also tend to be more profitable than its U.S. ones. On top of this, the company's operations outside of the U.S. generate returns that are superior to its cost of capital -- thus creating shareholder value in the process.
Costco's international sales were hurt by the stronger dollar in the second half of 2015. However, the dollar is likely to stabilize as we settle into the New Year, thereby transforming Costco's international operations into a catalyst for the stock in 2016.
A lofty valuation
The year 2016 is shaping up to be a winning one for Costco given the catalysts outlined above. However, the stock's valuation today is something investors should keep in mind. It seems most of the upside is already reflected in Costco's share price, which is north of $163 today. The stock looks expensive with a price-to-earnings growth, or PEG ratio, of 3.74, and a P/E of 30. These numbers are both among the highest in the industry.
With much of the upside already priced into the stock, and international expansion in the early stages, Costco's best year yet may still be a few years into the future. Nevertheless, Costco is a solid stock with plenty of long-term potential. For that reason, the warehouse giant should continue to reward existing shareholders for many years to come.