Costco Wholesale (COST 1.01%) members are used to scoring deals at the warehouse, but right now they're also getting a break on their subscription fees. The retailer typically raises its annual charges about every five years; yet, more than six years have passed since the last boost in 2017.
Wall Street is getting a little nervous.
Most of Costco's annual earnings come from fees, after all. And without those regular increases, it becomes much harder to keep profits rising. With that key risk in mind, let's look at why Costco's management might be reluctant to announce an increase today and what that could mean for the business.
Two trends
Costco's latest sales trends haven't been impressive. While customer traffic is up (rising 5% in the U.S. last quarter), shoppers aren't nearly as enthusiastic about spending money today. Average transaction sizes fell 4% in the most recent quarter, weighing down overall growth. Sales in the fiscal year that just closed were up 5%, compared to the prior year's 11% spike.
The weakness is limited mostly to big-ticket, non-essential purchases. E-commerce sales were down 5% this year, while last year they had risen 10%. Most of Costco's digital sales are in categories like appliances, home furnishings, and jewelry, and the retailer isn't immune to the demand pullback that's been happening in those areas.
Not a big deal
The good news for the business is that Costco isn't taking as big a hit from this shift as its peers. In contrast to a company like Target (NYSE: TGT), which boosts profit margins when demand tilts toward higher-priced products, Costco's margins remain stable due to its price leadership model. This approach limits the earnings upside when demand spikes, as it did through most of 2022. Yet it protects shareholders from declining margins during cyclical downturns.
COST Operating Margin (TTM) data by YCharts
Costco still earns about the same 3.5% operating margin as it did a year ago, and meanwhile Target's comparable figure has been cut in half over the last several quarters. So, from an investor's perspective, there isn't much of a financial penalty from shifting demand preferences, or from Costco's reluctance to hike its fees at a time when shoppers are feeling more cautious on spending.
A raise is coming
With that being said, Costco does need to continue raising fees to maintain its pricing advantage. Costs for the past year have been rising on everything from wages to transportation. Even Costco's highly efficient business can't fully offset those shifts for very long.
The retailer isn't likely to offend its membership base with the next fee increase, either. In addition to that healthy customer traffic metric, Costco's renewal rate is further evidence that shoppers are getting plenty of value from their subscriptions. A record 92.7% of members are renewing their annual commitments right now.
Management says investors can expect to see that increase, even if it is being delayed by the cautious consumer spending environment right now. "We feel good...about all the attributes of member loyalty and member growth," CFO Richard Galanti said in a late September conference call. "You'll see it happen at some point," he continued, referring to the next fee increase.
The stock might get a quick boost following the announcement of that increase, as Wall Street celebrates the likely jolt to Costco's earnings. But keep in mind that the retailer will likely direct essentially all that extra cash toward keeping its prices low. That's the surest path the retailer has toward continued market share gains over the long term.
