Is This a Red Flag for Costco Stock?

Costco Wholesale (COST 1.70%) is a pretty straightforward retail stock. It doesn’t come with the glitz and glamor of tech, and it’s been a steady market-beating stock over its decades on the market. But the past few months have been a nonstop, action-packed story for the warehouse giant.

The most recent announcement is that it’s cracking down on non-members coming into the store. Let’s see what’s been happening at Costco and whether or not this is something to worry about.

Keeping up With Costco

There’s been a lot going on at Costco. Here’s a list of significant events for Costco over the past few months in chronological order:

• Craig Jelinek stepped down as CEO, and Ron Vachris took over.
• Costco issued a $15 special dividend.
• CFO Richard Galanti stepped down, and Gary Millerchip took over.
• Costco announced its highly anticipated fee hike.

As of last week, the newest entry on this list is that Costco wrote on its website that it is installing card scanners in all of its locations to crack down on membership sharing.

How Costco makes money

The membership is a key piece of Costco’s operating model. Members pay $60 annually for the privilege of shopping at Costco’s warehouses, but in September that’s going up to $65 for a basic membership and $130 for an executive membership.

Costco’s products have low markups, and the company keeps its warehouses low-maintenance so prices cover associated costs. It makes most of its money from the memberships that it sells, and it keeps volume and sales high by providing value for members.

For example, here’s how it played out in the fiscal third quarter (ended May 12): Sales were $58.5 billion, including $1.1 billion in membership fees. Gross margin was 10.8%, and net income came in at $1.7 billion.

It’s easy to see why it would be important for the company to be strict about membership sharing. So why the sudden announcement?

Change leads to change

If you shop at Costco, you know that Costco already has mechanisms in place to keep out non-members. You have to show your card upon entering the store and then again at checkout.

But straightforward and maybe even boring it may be, old and stodgy Costco is not. E-commerce is one of its biggest growth drivers, increasing nearly 21% in the third quarter, and Costco has installed self-checkout counters in many stores. Non-members who manage to bypass the entrance can still shop and check out in these lanes.

Management said that membership sharing increased during the pandemic, but it was lax in enforcing the rules when shoppers were under severe pressure. However, membership sharing has become more rampant now that it has self-checkout counters and shoppers aren’t required to show their cards to a cashier.

Management was dealing with member complaints, “So the view was we needed to just shore that up a little bit, and we did,” former CEO Rochard Galanti said back in March. He said that in a pilot program to curb membership sharing, Costco was making more money from new sign-ups than it was losing from turning away non-members, but that it was more an issue of “hygiene.”

Is this a red flag?

This isn’t actually new since it’s been in test mode for several months in certain locations. The news is that it’s now going to be spread to all locations.

It doesn’t appear that Costco is doing this because it needs the money. Membership and renewals are consistently strong, and that hasn’t changed recently. U.S. and Canada renewal rates increased a smidgen in the third quarter to 93%, and paid household members increased 7.8% year over year.

It’s more likely, as Galanti said, that Costco is doing this to keep operations running smoothly and be able to provide value to its members. It could also be related to the change in management. Vachris is a Costco veteran, but Millerchip comes from the CFO role at Kroger. It wouldn’t be surprising to see them making a few changes.

Costco has been keeping investors on their toes over the past few months, and investors should definitely keep their eyes open. But Costco is steady and reliable, and this will likely end up being more newsy than noteworthy.