If you're a Costco Wholesale (COST -0.71%) member, you're probably well aware that an annual membership costs $60 (or $120 for an executive membership). If you're a Costco shareholder, you may or may not be aware that keen investors stay alert to when Costco raises its membership fee.
The fee is an important element of Costco's formula, which we'll outline below. Indications point to a possible fee raise being on the horizon -- and shortly. Here's why that's not too bad for members and great for investors.
Why does Costco charge a fee?
According to Costco, "Our membership fee allows us to offset many of our operating costs and price our merchandise lower." Costco is all about the low price. There are two aspects of making that work: charging a membership fee to cover operating costs, and selling items in larger quantities.
Its focus is on driving high volume, which allows it to post strong profits even at low margins. Its gross margins are typically around 11% to 12%, which are the lowest in the industry. Its gross margin was 10.2% in the fourth quarter (ended Aug. 28).
Members keep paying up
Members clearly like what they get. Membership renewal rates, which are typically around 90%, reached record highs in the fourth quarter, at 92.6% for U.S. and Canada and 90.4% for international. Cardholders climbed to 188.9 million, or a 6.5% increase over last year. That makes sense. As inflation hits, customers are reaching for the lowest prices.
Executive members are an even more important part of the business, and each quarter, more members make the jump. In the fourth quarter, executive members increased by 1.2 million, or about 4%, from the third quarter, to 29.1 million. They make up 44% of total members but 72% of total sales.
Why raise the fee?
Considering the inflationary environment and its own rising costs, it would make sense that now would be a good time to raise the fee. But when asked about it, CFO Richard Galanti consistently says that when Costco knows, they'll let everyone else know. On the fourth-quarter earnings call, he reiterated that "there are no specific plans regarding a fee increase at this time."
However, there are reasons to believe that might change soon. Aside from the obvious inflation aspect, the last three increases were, on average, five years and seven months apart. That time frame comes up in January of the coming year, or just over two months from now.
On top of that, raising the fee gives Costco more breathing room to keep its prices down. Galanti stressed that Costco is top-line focused, and getting more revenue from fees means there's less pressure on pricing. He said that when Costco has raised the fee in the past, it has plowed the extra money back into providing more value for members. As sales growth begins to slow down in the tight economy, there's good reason for both Costco and its customers to focus on adding value.
How does it affect shareholders?
Costco's stock price is down 17% this year, slightly better than the S&P 500's 22% loss. After two fabulous years, Costco is beginning to feel the pressure of this difficult economy. Raising the fee is a careful decision by management, but members who know they're getting the lowest prices aren't likely to drop their memberships, so it's more money for Costco. It may even lead to higher sales volume since shoppers will want to get the most bang for more bucks. It would be a strong show of confidence -- and a boost in the stock price is likely to follow.
