NEW YORK (TheStreet) -- The U.S. Dollar has risen significantly versus virtually every other currency around the world. In the last month alone, the U.S. Dollar Index has risen by over 4%. Since July of 2014, the U.S. Dollar Index has increased by 17.5%. This trend is not likely to reverse soon; the Federal Reserve is widely expected to raise interest rates in 2015. This will further strengthen the U.S. Dollar relative to other currencies.
The retail sector in the U.S. stands to benefit from a strong dollar. When the dollar appreciates versus other currencies, it means that the dollar can buy comparatively more goods than before. This brings down cost of goods relative to revenue for retailers in the U.S.
Not all retailers stand to gain equally from a stronger dollar. Of the three largest U.S. discount retailers, which ones present the best investment case for those looking to profit from the stronger dollar?
Saying Wal-Mart is the largest discount retailer is an understatement. It has over 2.5 times as many sales in the last year than Costco and Target combined. Wal-Mart generates about 70% of its revenues inside the U.S.
Despite its 'Buy American' publicity campaign, the company still purchases the vast majority of its products internationally. In the Buy American campaign, Wal-Mart pledged to buy $50 billion in U.S. products over 10 years. While $50 billion sounds impressive, over a 10 year period, this amounts to about 1% of Wal-Mart's revenues.
Wal-Mart's basic business model is to purchase goods at the lowest possible prices. A strong U.S. Dollar gives the company the ability to purchase goods for lower prices overseas and sell them in the U.S. Wal-Mart has long been a favorite of The 8 Rules of Dividend Investing.
Wal-Mart stands to benefit from a strong U.S. dollar, although not as much as the companies below. This is because Wal-Mart does have sizable international operations which will experience headwinds from a strong U.S. Dollar. Still, the company generates more revenue in the U.S. than abroad, and a strong U.S. Dollar is a net positive for the company.
Wal-Mart may be the largest discount retailer in the world, but Costco may very well be the best for consumers. The company operates on razor thin margins and makes most of its profits from membership dues.
About 70% of Costco stores are located in the U.S., with the remaining 30% spread across Canada, Mexico, Japan, Australia, United Kingdom, Korea, Taiwan, and Spain. In fiscal 2014, the company opened 17 new locations in the U.S. and 12 Internationally.
Costco's domestic-international store mix is very similar to that of Wal-Mart's. Costco also purchases the majority of its products internationally. As a result, the company stands to benefit from a strengthening U.S. dollar. Analysts seem to agree. Ten out of 17 analysts have raised the company's current year earnings-per-share forecast.
Target recently announced it was exiting its botched Canada expansion. The exit will have a cost of about $500 to $600 million. With Target's exit from Canada, it is based exclusively in the U.S. Target is the largest discount retailer that is focused exclusively on U.S. markets.
The company is expecting 2% to 3% comparable store sales growth in the U.S. in its most recent quarter. The strong U.S. Dollar is providing tailwinds for Target. More than any other major discount retailer, Target benefits from a strong dollar. The company benefits by being able to purchase more overseas for every dollar spent, and sell it for low prices in the U.S. This should expand the companies margins and reward shareholders with increasing earnings-per-share.
All nine of Target's primary analysts raised their "Next Year" guidance numbers for the company in the last 30 days. The company stands to benefit from both a strong U.S. Dollar and the divestiture of its Canadian operations. Without the lead-weight that was Canadian operations, Target can use cash flows to reward shareholders with share repurchases and additional store openings in the U.S. Additionally, the company has a 2.8% dividend yield and is a Dividend Aristocrat with 48 consecutive years of dividend increases.
The 3 largest discount retailers in the U.S. will all benefit from a strong U.S. Dollar. Target will benefit the most, because it does not have international operations with the announced divestiture of its Canadian business. Wal-Mart and Costco both generate the majority of their revenue in the U.S., despite both having sizeable international operations.
Of the two, Costco has the better long-term growth prospects. The company has a reputation for fair pay and stocking interesting merchandise that consumers enjoy. Wal-Mart has a reputation as "cheap." They pay workers much less than Costco and serve a less affluent customer base. Wal-Mart's stock is much cheaper than Costco's, however. Wal-Mart currently trades at a price-to-earnings ratio of just 18.1 versus 29 for Costco. Target trades at a price-to-earnings ratio of 31.1, for comparison.
Investors looking to gain from the strong U.S. dollar should choose Target. Investors looking for growth but not value should choose Costco. Investors looking for a mix of dividends, value, and growth should invest in Wal-Mart in the retail sector.
This article is commentary by an independent contributor. At the time of publication, the author held WMT.