Costco (COST -0.60%) investors aren't used to being disappointed. The warehouse retailer's stock has trounced the S&P 500 over the last five years even while the company sent billions to its shareholders through special dividend payouts. Factoring in those payments places Costco's returns at over 230% -- more than double the market's 100% rally since March 2021.
Those are some head-turning gains for a retailing stock that's one of the least profitable in its peer group. We're not talking about a fast-growing tech giant with double-digit operating profit margins, after all. Costco earns less than Walmart for every dollar of revenue it books. You can find much faster sales growth both inside and outside of its consumer staples industry niche as well. Its current stock price valuation is near a record, meanwhile, and so investors are facing elevated risk around the company disappointing Wall Street.
Let's look at the biggest ways Costco might come up short this year to deliver subpar returns in 2024.
1. No fee hike
The biggest source of earnings for the warehouse giant is membership fee income, and it isn't even close. Costco generated $1.1 billion of subscriber fees last quarter, which accounted for 65% of its net income for the period. The rest was produced by Costco's merchandise sale markups.
That's why it makes sense that Wall Street is salivating at the prospect of another fee hike on the way. It's been about seven years since the last increase and Costco tends to increase these fees every five or six years. But the next one might not arrive in 2024. There are no concrete plans to push an increase through as of early March, management said in a conference call. Investors will be disappointed if another year passes without this key jolt to cash flow and earnings.
2. Low profit margins
Costco's price-leadership selling approach is clear enough from its rock-bottom profitability metrics. Gross profit margin sits at just 12% of sales today, compared to closer to 25% of sales for both Walmart and Target. The warehouse giant is similarly at the bottom of the pack when it comes to operating profit margin, which hovers around just 3% of sales.
Investors might start demanding more from Costco in 2024 and beyond. Walmart is boosting its margins toward 5% of sales with help from a booming e-commerce segment. Costco is getting good growth from this niche as well, with recent hits including gold bars and gift cards. Wall Street is hoping that the retailer can meaningfully increase its profit margin, but it's likely Costco will continue pouring any excess cash right back into keeping its prices unbeatably low.
3. Weaker renewals
While customer traffic is a core metric to follow for most retailers, Costco investors have an even better one to judge its shopper engagement against: renewal rates. The chain has been steadily improving this rate, pushing deeper into record territory. A full 93% of members are renewing their subscriptions today, in fact.
There's a fight going on for these shoppers, though. Walmart said in its recent earnings call that some of its fastest growth is coming from higher-income customers in the grocery niche. Target is working hard to build back its consumer discretionary business after it slumped in the past year, too. If rivals make inroads in prying away some Costco customers, reducing its renewal rate in the process, then the stock could be punished in 2024.
