Membership fees account for just over half of Costco's (COST 0.32%) operating income. This is why keeping dues-paying members happy is vitally important to the business. But that's left the company in a quandary driven largely by its own success. Here's why this retail giant has no choice but to keep opening new stores.
Costco is fueled by the membership model
Costco's customers pay a yearly fee to shop at its stores. That dramatically changes the dynamics of the relationship between the retailer and its customers. And given that so much of the company's operating income comes from membership fees, Costco has to make sure it keeps customers as happy as possible. To that end, it had a lofty 90% global membership renewal rate in fiscal 2023.
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In other words, Costco knows just how important membership dues are and it is working hard to keep members happy. After all, with such a high renewal rate, its members are an annuity-like revenue stream. On a day-to-day basis, keeping members happy is mostly about ensuring that Costco has the lowest prices for the best products. Good customer service is important, too, which is why the company also works hard to ensure it has good relations with its employees.
But there's one aspect of customer service that Costco keeps bumping up against in a not-so-good way. The company is something of a victim of its own success. Management recently noted that it knows customers sometimes don't want to shop at its stores because they are too crowded. During Costco's fiscal second-quarter 2024 earnings call, CFO Richard Galanti commented, "We find existing members that sometimes will say, 'I don't want to go there. Too busy today.'"
Costco's problem and opportunity
While it's hard to argue that having popular stores is an entirely bad thing, if busy stores hurt membership renewals, it most certainly isn't good. According to Galanti, 150 of the retailer's U.S. locations are generating over $300 million in sales, with 40 producing more than $400 million. That's a lot of money, but it only happens because of the number of customers going to those specific locations. Galanti added, "But the volumes that we're now doing in these locations, we've got to bleed some of that off."
NASDAQ: COST
Key Data Points
That's why the company's 2024 new store plans include around 20 new locations in the United States. That's out of a net 28 new openings. While keeping existing customers happy is the big reason for many of these new locations, there are secondary benefits as well.
For example, the new stores will start off from a position of strength because they have a built-in customer base. They will also benefit from the ability to move trained employees from the older location, so starting up the new locations will be easier, too. The secondary stores, meanwhile, can draw in new customers of their own, further increasing the overall member base of the company. This is a situation in which keeping customers happy leads to winners all around, including investors who benefit from Costco's ongoing business growth.
This growth stock still has room for expansion
Costco will not interest value investors given that it is usually afforded a premium valuation by the market. That premium will also turn off income investors, because a high share price has resulted in a miserly dividend yield of around 0.5% -- albeit with occasional large special dividends to supplement its regular dividend payout.
However, if you are a long-term, growth-oriented investor, Costco is the type of stock that should be on your wish list to buy during the next bear market, if not your current buy list. You will definitely be paying full price today, but the retailer's growth is still going strong. And the really interesting thing is that Costco has no choice: Its customers are demanding that it keep opening new stores.
