Benjamin Franklin wrote, "Nothing is certain except death and taxes." But warehouse-style retail chain Costco Wholesale (COST 1.01%) is making a strong case for two more certainties.
Costco's combo meal for a hot dog and a soda costs $1.50, and its rotisserie chicken costs $4.99. These prices haven't changed since 1984 and 2009, respectively, even though inflation has sent the price of everything else soaring during this time.
Whether it's their price stability or just how tasty they are, these foods have given Costco an extraordinary fanbase. The company sells over 150 million hot-dog combos annually, which reportedly outpaces combined hot-dog sales across all of Major League Baseball.
Moreover, Costco sold 117 million rotisserie chickens in 2022 and probably even more this year. Judging by the line of customers waiting for more chickens to be brought out, it still might not be completely meeting demand.
Hot dogs and rotisserie chickens are big business for Costco, and there's a lesson in there for investors. But before I tackle that, I want to point out that the company has a new and surprising "hot" product that captivated its members in the most recent quarter.
The surprise item to kick off fiscal 2024
Costco reported financial results for its fiscal first quarter of 2024 on Dec. 14. During Q1 (which ended on Nov. 26), management said that it sold $100 million in gold. That's not exactly what you'd expect from a retailer mostly selling food.
Costco started selling gold online to only its members last quarter, with a two-per-member limit. And on the earnings call, CFO Richard Galanti said that they'd sell out within hours. This is somewhat surprising because these one-ounce gold bars reportedly sold for a small premium to the spot price of gold.
No matter what the exact reason was for the enthusiasm, Costco's members apparently believe buying gold is a good perk. And that's good news for investors.
How Costco makes money
The late great Charlie Munger said he was addicted to Costco stock because he was in love with the business model. The company doesn't intend to operate as many locations as other big-box competitors. Rather, it focuses on more limited markets that can support heavy sales volume per location.
From fewer than 900 locations, Costco generated more than $237 billion in sales in its fiscal 2023 -- an incredible volume. However, the company makes surprisingly little profit from its sales. Its gross margin on merchandise was a paltry 11% in fiscal 2023. Add in operating expenses, and it's virtually a breakeven business.
Costco's goal is to deliver value for its members, so operating near breakeven is important. But the company makes up the difference with its membership fees. It has 72 million member households as of Q1. And with a greater-than 90% membership renewal rate, they obviously believe the Costco membership is worth it.
From an investment perspective, the great thing about Costco's model is that new membership fees drop down to the bottom line, allowing profit growth to outpace revenue growth. The chart below shows the trend between revenue and free cash flow (on a per-share basis) over the last 10 years.
Costco's stock price might have gotten a little ahead of free cash flow lately. But the stock price has unsurprisingly followed the company's cash flow higher over the long term.
Therefore, the name of the game for Costco is to keep its members happy and attract more. In so doing, it can earn more membership fees, and cash flow can increase. That's where hot dogs, rotisserie chickens, and even gold bars come in to this discussion.
Due to their its popularity, Costco is determined to maintain this pricing on its most popular items. To keep things as close to breakeven as possible, the company has opted to reduce its costs rather than increase its prices. And this has led to some out-of-the-box maneuvers for the discount-warehouse chain.
More than a decade ago, Costco opened its own hot-dog manufacturing facility in California to reduce its cost basis. Then in 2019, the company opened a chicken plant in Nebraska that can process two million chickens daily.
It's a lot of work for Costco to vertically integrate food production like this. But it supports keeping prices low for more than 100 million chickens and over 150 million hot dogs. Keeping prices low keeps members happy. And that's what it's all about.
Costco has yet to announce its own gold mine. But given how far the company will go to please its members (insert tongue in cheek), shareholders shouldn't completely rule it out.
