Costco (COST -0.09%) falls into the retail sector, but it isn't your normal retailer. That's because the company is a wholesale club. The operative word there being club, because it charges a membership fee.
In the fiscal fourth quarter of 2023, the company reported that 92.7% of its club members renewed their memberships. This is a vital stat to understand if you are thinking about buying the stock.
A little math with Costco's income statement
When you examine Costco's income statement, you'll see two items under revenue. The first is exactly what you would expect from a retailer: net sales. This figure basically includes the revenue from selling all of those giant packages of toilet paper, clothing, rotisserie chickens, and $1.50 hot dog/soda combos. The figure in fiscal 2023 totaled $237.7 billion.
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Right below that number is membership fees. Membership fees contributed about $4.6 billion. That's a drop in the bucket compared to product sales, with membership fees amounting to just about 2% of the top line. From a top-line perspective, that's almost not worth worrying about.
But things get a lot more interesting when you consider the costs associated with the selling of products. Merchandise costs in fiscal 2023 totaled roughly $212.6 billion, and selling, general, and administrative costs were nearly $21.6 billion. That sums up to about $234 billion. Using back-of-the-envelope math, that means the selling of products produced gross profits of about $3.7 billion.
But that doesn't include the membership fees, which basically have little to no cost associated with them. Adding the membership fees brings gross profit for the retailer in fiscal 2023 to $8.1 billion. There's no need to pull out a calculator here -- $4.6 billion in membership fees is more than 50% of the company's gross profit.
Keeping customers happy is a big business for Costco
This is why the company's 92.7% renewal rate in the United States and Canada is so important (the global rate was a still-strong 90.4%). The revenue Costco generates from renewing members is basically like an annuity income stream.
It might even be more important than revenue from product sales. That's highlighted by the fact that the company is so aggressive on price despite the headwind on profit margins. Simply put, low product costs keep customers happy and gets them to renew their memberships, year in and year out.
Now step back and think about the company's long-term plans. It wants to continue opening new stores to grow its geographic footprint. In fiscal 2023, it opened 23 new locations. In the first quarter of fiscal 2024, the target is 10 new stores. While the goal is to increase sales, the key is that each new store means adding new members.
In fiscal 2023 membership grew 7.9%. That helps to build the annuity-like income stream from membership fees. And as long as the company keeps its product costs as low as it can, renewals are likely to be resilient even during recessionary periods.
A long-term buy for growth investors
Costco's shares are still about 8% below their 2022 highs. But the stock isn't exactly cheap, with a price-to-sales ratio of little over 1 times, versus a five-year average of roughly 0.92 times.
While value-focused investors might want to wait until the stock is cheaper, investors who think in decades might still want to buy Costco today. Basically, Wall Street is rewarding it well for having a robust business model. As long as the company can keep executing the successful membership-focused plan that has gotten it this far, the future looks like it remains very bright.
