Costco's First Membership Fee Hike in 7 Years: What It Means for Stock Prices

Costco typically raises its membership fee once every five and a half years, with the last increase occurring in June 2017. The market had originally anticipated a price hike by the end of 2022 or the beginning of 2023, but Costco opted to delay the increase due to consumer struggles with high inflation. The prospect of a fee increase has been eagerly awaited by investors and analysts this year, with company executives signaling during the May earnings call that it's a matter of "when" rather than "if."

This Wednesday, Costco has announced that it will increase annual membership fees for its U.S. and Canada members. Effective September 1, the fee for Gold Star, business, and business add-on members will increase from $60 to $65, while the executive membership will cost $130 instead of $120. These changes will impact approximately 52 million memberships, with slightly over half being executive.

Moreover, benefiting from sustained demand for food and essential household items, Costco continues to deliver robust sales performance. According to the latest report, the company's sales in June grew by 7.4% year on year, with comparable sales excluding fuel and foreign exchange, up 6.9% during the five-week period ended July 7. Notably, its e-commerce business has shown outstanding growth, surging by 19.1%, highlighting its strong growth potential. The company also announced a quarterly dividend of $1.16 per share.

From a business model perspective, Costco differs from traditional retailers who rely heavily on product sales to generate profits. Costco derives over 70% of its profits from membership fees, making the size and loyalty of its membership base crucial to its profitability and growth potential. To attract more members and maintain high levels of loyalty, Costco employs a low-price strategy to entice customers and gradually establish in-store spending as a regular habit for its members.

Costco is renowned for its low-priced, bulk-packaged products and its focus on a limited number of high-quality SKUs. The company carries around 4,000 SKUs, significantly lower than the US retail industry average of 14,000 and far fewer than Walmart's more than 100,000 SKUs. This means that Costco has greater bargaining power when purchasing larger quantities of individual items. Although the low-price strategy results in low gross margins, the company makes up for it with higher asset turnover efficiency.

This model helps to provide a better shopping and service experience for customers, attracting more consumers to become members and pay membership fees. In turn, the substantial membership income supports the company's continued low-price sales, creating a virtuous cycle. This is also reflected in Costco's outstanding operating efficiency, including outstanding store sales, sales per square foot, and sales per employee.

Given the high renewal rates, new registration numbers, and customer loyalty, and the fact that renewal rates stayed fairly steady the last time Costco raised its fees, the market generally expects the same response to this year's fee increase. This move is expected to boost Costco's profits, particularly in light of the company's recent crackdown on shared membership cards. The increased profitability from membership fees also opens up further opportunities for Costco's low-price strategy. The story of the virtuous cycle continues.

According to a research note by Stifel analysts, released on Wednesday following the announcement, the decision to increase membership fees will bolster Costco's value proposition. This move will enable the company to offer more competitive prices across a wide range of products, leading to an increase in customer frequency and foot traffic, while simultaneously attracting new members and retaining existing ones.

Following the announcement of strong June sales and the widely anticipated membership fee increase, Baird has raised Costco's target price from $850 to $975, while maintaining its "outperform" rating on the stock, which is the highest target price in the entire market.The organization stated that although some of the proceeds from the fee increase will be reinvested, the move will provide "more oxygen" to support Costco's leading position in terms of traffic momentum, market share gains, and member loyalty. This year, the stock's average target price has been consistently raised, with five firms setting target prices above $900 since July.

A cautious approach is always necessary, and for Costco, high valuations and overly optimistic market expectations are factors that cannot be ignored. Since the beginning of this year, Costco has risen by 34%, outperforming the S&P 500's 18%, and has more than doubled since the outbreak of the COVID-19 pandemic.

Some cautious investors may be concerned that the anticipated membership fee increase has already been priced in, and that the significant increase in the stock price in the previous period may lead to some profit-taking as a result of the recent good news.