The membership-based retail business giant Costco Wholesale Corporation (COST) announced a delayed price hike for its memberships. Going by empirical evidence, these price hikes are likely to drive earnings growth in the foreseeable future. From September 1, the members-only chain will raise the price of its Gold Star membership to $65 from $60 and its premium Executive Membership to $130 from $120. This decision makes Costco’s valuation multiples more reasonable, and I am bullish on the stock, as I believe there is more room for the company to grow.
Higher Membership Fees Will Boost Earnings
At the end of the last quarter, there were 52 million Costco members — 27 million Executive members and 25 million Gold Star members. Given this large and sticky customer base, analysts were expecting Costco to hike membership fees in late 2022 or early 2023, which did not materialize.
Costco, on average, raises its membership fees every five and a half years, which would have put Costco on track to raise fees in late 2022 or early 2023. However, as revealed by new CFO Gary Millerchip during the fiscal third-quarter earnings call on May 30, the company delayed this planned price increase amid consumer concerns about higher inflation and the challenging economic outlook.
A closer look at Costco’s financial performance reveals the important role recent membership fee hikes will play in boosting the company’s net income. The company operates on low profit margins, selling products at discounted prices, compensated by higher volumes. Costco’s net sales have increased by around 10% annually for the past 35 years, three times faster than overall retail spending. This above-average growth is a direct result of the success of its membership model.
The retailer reported $1.1 billion in membership fee revenue for the last quarter and $4.5 billion for Fiscal 2023. Membership growth at Costco has helped sustain its bargain prices and clout with suppliers, but without it, the company would have reported net losses in recent years, highlighting the importance of membership growth.
Costco incurred $51 billion in merchandise costs in the most recent quarter to generate net sales of $51 billion. Without the membership fee revenue of $1.1 billion, Costco’s net income would have been negligible.
The announced fee hike will have a direct positive impact on Costco’s profitability. That’s because the company does not incur substantial maintenance costs to offer these memberships, meaning this business is a very high-margin business compared to the sale of merchandised products at its stores.
The Competitive Position
When compared to its rivals, Costco’s membership fees are at the higher end. While Costco’s membership fees will increase to $65 and $130 soon, BJ’s Wholesale Club Holdings (BJ) is offering its memberships for $55 and $110, and Walmart- (WMT) owned Sam’s Club is offering its memberships for $50 and $110. Sam’s Club made identical $5 and $10 increases to its Basic plan and Premium plan back in 2022.
Costco, despite charging comparatively high membership fees, has an edge over its competitors because of two main reasons.
First, Costco offers a 2% cashback offer up to $1,250, a higher limit than both Sam’s Club and BJ’s Warehouse Club, which are only offering 2% cashback up to $500. Second, the average U.S. Costco member has a higher household income of $100,000 compared to $86,900 for Sam’s Club and $76,300 for Walmart, according to Kantar’s findings.
Costco’s competitive advantages can be seen in how its membership model has shielded the company from a broader pullback in retail sales growth and discretionary spending in the U.S. during turbulent economic conditions. Data from Bloomberg Second Measure also reveals that average sales per Costco member have increased at a faster pace compared to BJ’s and Sam’s Club between 2019 and 2022, which is a testament to Costco’s competitive strengths.
Is Costco Stock a Buy, According to Analysts?
The increase in membership fees at Costco has been positively received by Wall Street analysts. This price increase will add approximately $395 million to EBIT over two years, excluding reinvestment, according to Morgan Stanley (MS) analyst Simeon Gutman, who has a Buy rating on the stock. The analyst believes these price hikes will not materially impact membership renewal rates because of the strong customer loyalty enjoyed by the company.
UBS (UBS) analyst Zeyn Burak also welcomed the move and wrote in a note to clients that incremental profits from this fee increase would be used to offer subsidized products to customers, strengthening the company’s market position as a discount retailer. Jefferies analyst Corey Tarlowe also believes this price hike will lead to a 3% growth in EPS in the next couple of years. Bank of America (BAC) analyst Robert Ohmes also praised the company’s decision to finally increase membership fees.
Meanwhile, Barclays (BCS) analysts believe Costco may see a temporary reduction in store traffic but expect the long-term impact of this decision to be a net positive.
Overall, based on the ratings of 25 Wall Street analysts, the average Costco stock price target is $910.05, which implies upside potential of 11.5% from the current market price.
The Takeaway: Costco’s Earnings Will Get a Boost
Costco’s delayed membership price hike is a strategic move expected to bolster profits significantly. Despite the increase in membership fees, Costco is still likely to see strong membership growth in the long run, and retention rates are likely to be stable, supported by market-leading member benefits and an affluent customer base.
