Costco (NASDAQ:COST) operates a warehouse club business model where it charges annual membership fees to customers and, in turn, offers deep discounts on select merchandise. Owing to cost pressures, Costco increased its membership fees by 10% for new members effective November 1, 2011, and for renewal members effective January 1, 2012. In this analysis, we discuss the importance of increasing penetration of executive members as a major growth factor for Costco.
We maintain a $94 price estimate for Costco’s stock, implying a near 10% premium to the current market price.
Increasing penetration of executive members
Costco has witnessed an impressive increase of 30% in its cardholders between 2006 and 2011. It has been consistently involved in promotional activities to increase its membership count. At present, Costco charges $55 as annual fees from its U.S. Goldstar (individual), Business, Business add-on and Canada Business members, whereas from its U.S. and Canada Executive members it charges annual fees of $110.
We believe the increasing penetration of executive members is very crucial for Costco’s future growth. The points discussed below support our viewpoint.
- Executive members tend to have higher renewal rates and spending than other members. For example, membership renewal rates are about 92% for executive members, 4% to 5% higher than the overall membership renewal rates. Also, the executive members account for about 60% of total Costco sales.
- Executive membership penetration is on an upward trend and has increased from about 23% in mid 2007 to about 38% in 2011. As the proportion of executive members increases, the number of cardholders discontinuing the membership is likely to decline.
- In 2011, membership fees increased 10.4% to about $1.9 billion primarily due to increased penetration of the higher-fee executive membership program and new membership sign-ups.