Costco (NASDAQ: COST) just answered investors’ biggest question. With the warehouse giant’s last fee increase in 2017, investors have been wondering when the next one would happen. After all, the company has traditionally hiked fees once every five years.
Finally, earlier this month, Costco made the move, saying it would increase its standard and premium membership fees as of Sept. 1. An increase in fee income will add to Costco’s revenue, which is great news, but it does come with one element of risk: It also could result in some people dropping their memberships or potential new members deciding to go elsewhere.
Right now, as we consider whether this fee hike will benefit revenue or not, we may wonder what path Costco stock will take in the coming months. Will the promise of additional revenue outweigh any risks and lead the stock higher? Let’s take a look at what history says.
Costco’s business model
First, it’s important to consider Costco’s business model, one that has helped earnings advance during just about any economic environment. The company offers dirt cheap prices on a wide range of general merchandise items and on essentials like gasoline and food — it’s known for keeping its rotisserie chickens at $4.99 and hotdogs at $1.50 year after year, regardless of inflationary pressures. So, even during tough economic times, shoppers know they can get the best prices at Costco and therefore flock to the warehouse giant.
To access these great deals, though, you have to pay an annual membership fee. This fee is a fantastic tool for Costco because it ensures a steady stream of recurrent annual revenue — and at a high margin, because offering memberships doesn’t require any major investment.
And the existence of a fee incites members to do as much of their shopping as possible at Costco, so they can get their money’s worth. All this keeps them coming back, resulting in renewal rates of more than 90% at Costco in the U.S. and Canada.
Membership fees actually make up a key part of Costco’s profit because, as mentioned above, they are high margin. Though the company generated $57 billion in net sales in the most recent quarter, merchandise costs totaled more than $51 billion — meaning Costco doesn’t generate significant profits from sales of goods in its warehouses. In the quarter, membership fees contributed more than $1.1 billion to revenue.
This is why it’s important to keep membership income recurrent and help it grow. So, a membership fee increase, such as the one just announced, is big news. Costco is now lifting U.S. and Canada Gold Star (individual), business, and business add-on membership fees by $5 to $65. The company will also raise its U.S. and Canada Executive Memberships by $10 to $130. The move affects 52 million memberships, and a little more than half of these are Executive level.
Costco’s performance after past fee increases
Now, let’s get back to our question about how this move may affect stock performance. As mentioned, Costco has increased membership fees about every five years in the past. Let’s consider how the stock performed in the two years following the past three fee hikes. These occurred in June 2017, November 2011, and May 2006.
On each occasion, Costco stock soared in the double digits in the two years following the increase. It gained 32% after the last hike, 43% after the 2011 one, and 33% after the 2006 increase. We also know that Costco’s earnings have increased steadily from the 2006 period, so over time, rate hikes haven’t negatively affected the company’s growth — instead, they’ve supported it.
Costco recently said that fee increases actually benefit members because they allow the company to offer the lowest possible prices. Yes, members will pay an extra $5 or $10 when renewing their memberships, but they’ll likely more than make up for that cost throughout the year as they pick up deals at Costco.
History shows us Costco shares tend to perform extremely well following a membership fee hike, and fee increases themselves haven’t spurred any sort of earnings slowdown at the company. Costco could lose some members, but it’s not likely to be significant, as most will probably be willing to give up a few extra dollars for a year’s worth of bargains.
Does all this mean Costco’s shares will soar over the next couple of years? Of course, history doesn’t repeat itself every time, and it’s impossible to predict share performance with 100% accuracy. But it is fair to say that Costco has what it takes to advance — and this warehouse giant makes a top long-term buy for investors right now.
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Adria Cimino has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale. The Motley Fool has a disclosure policy.
Will Costco Stock Soar After Its Membership Fee Hike? Here’s What History Says. was originally published by The Motley Fool
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