Costco Wholesale (COST 1.42%) operates in the retail sector, which means it is subject to massive amounts of competition. And yet it manages to differentiate itself in very important ways. Here's why Costco will be a much bigger company five years from now -- and the real metric that matters in the long run.
Join the club
Costco is a wholesale club, which basically means customers pay a fee for the privilege of shopping at the company's stores. This changes a lot about how this giant, global retailer operates.
For starters, it has a huge focus on low selling costs. But it has to if it wants to keep members happy, since they are paying to shop at the store. Nobody would pay extra for the opportunity to pay for things they could get elsewhere for less.
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This is important, because Costco willingly sacrifices profit margins on the goods it sells so that the prices are so attractive that its members want to renew year after year. It seems to be doing a good job on this front, given that the company's member renewal rate was over 90% in the fiscal third quarter of 2023. So the membership fees are, in some regard, an annuity-like revenue stream. Don't underestimate that fact.
To put some numbers on it, the company produced product sales of $52.6 billion in the fiscal third quarter of 2023. Membership fees were far lower, at a touch over $1 billion. But the cost of operating the retail business was around $52 billion (merchandise costs plus selling, general, and administrative costs). So the retail business only generated around $600 million of gross profit, while the membership fees pitched in about $1 billion.
Those are round numbers, but they tell the important story. Of the $1.679 billion in operating income Costco reported in the fiscal third quarter of 2023, a lot more came from membership fees than from product sales. Sales are important, but membership is the big number for Costco.
Getting bigger
Roughly five years ago, Costco's membership stood at around 51.6 million households. In the fiscal third quarter, it was up to 69.1 million. In the third quarter of fiscal 2018, membership fees brought in $737 million, compared to the roughly $1 billion noted in the most recent third quarter.
The membership numbers aren't moving massively, but they are trending steadily higher. That's partly driven by the company's expansion efforts. Five years ago, the retailer had around 750 locations. Today, that figure is up to 853. The goal is to keep opening new stores and, more importantly, using those stores to add more members.
In five years, more new stores will lead to more new members and an even larger contribution from membership fees. In fiscal 2023, the current plan is to have 26 new locations. That seems modest, but the stores have a large footprint, and each one attracts a significant number of members. A roughly similar, slow and steady pace seems reasonable over the foreseeable future.
A conservative estimate might be for around 85 million members five years from now and, perhaps, a membership fee run rate of something like $1.25 billion. Those are back-of-the-envelope figures that project future growth into the future, and then round down. But the broad idea is what's important. The bigger driver of Costco's gross profits is membership fees, and if the past is any indication, management is working hard to ensure it keeps growing.
Bigger and better
So, at the end of the day, Costco is likely to be a bigger company five years from now. But there are nuances that are vital to understand. Yes, more stores are likely to be a key factor and draw a lot of investor attention. And yet, the really notable figure will still be the number of new members the retailer brings in the door. The fees from an expanding membership base will actually be more important to the business than the sales those new stores generate.
