Costco (NDQ:COST): How to get a >20% ROIC in the supermarket sector? Membership fees are the secret sauce!

Costco (NDQ:CST) is a unique supermarket provider. It is arguably most famous for its quarter-pound all-beef hot dog and 20oz soda combo for US$1.50 at its food courts, a combo that was sold over 245m times in FY25 at a price unchanged since 1985. Now, CostCo is unique in the eyes of investors because it generates returns its peers can only dream of given its unique ways of making money. And no, it’s not by ‘selling more stuff’, but through the unique relationship it has with its customers.

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Overview of CostCo

The business model began with a company called Price Club and the first one was a converted airplane hangar in San Diego, opened by Sol Price. What was unique about it was that it was the world’s first membership warehouse club. The first CostCo Wholesale warehouse opened in 1983 in Seattle with the same model, and the company grew from zero to US$3bn sales in less than 6 years. The companies merged in 1993, settling on the name CostCo in 1997.

Today it has over 900 stores, over two thirds of which are in the USA. It remains headquartered in Seattle, specifically in the far-eastern suburb of Issaquah. But it has a growing presence in Australia with 15 stores right now, having opened its first in 2009. It is growing slowly by footprint, but quickly in terms of revenue and reputation, racing to A$5bn in annual sales and ranking ahead of the major supermarkets in consumer surveys in value for money, trust and customer experience.

The company makes over 20% ROIC and has for several years. It makes US$2,000 per square foot in sales, and each store sells over US$250m. Now of course, some shops will make less than that, but there are more good apples than bad ones. Consider that Walmart makes US$600/sq ft and Target (the American one) US$450/sq ft. And the average industry ROIC is little over 10%.

Now there are many reasons for this, including that (like McDonalds) it buys land where it is cheap. But there is one reason above all others. Namely, membership fees.

A membership warehouse club

We noted CostCo was a membership warehouse club and it means exactly what its namesake entails. It restricts access to members only. How does it purport to otherwise standout and make the fee worth it? Offer value for money, not just in terms of price but quality, brand and features. Costco warehouses are renowned for being large, but they keep only about 4,000 SKUs (stock keeping units) compared to the 30,000 found in many others. Its fees in the US begin at US$65 a year with an added tier worth US$165 delivering some benefits beyond merely being able to come in, including 2% cashback.

Beyond being an additional revenue source, it encourages loyalty and repeat purchasing, also enabling products to be sold at deep discounts while still keeping the company profitable. CostCo has 145.2m members, of whom 1.5m are in Australia. This trails Amazon’s 220m members, but is ahead of Walmart’s ~25m Plus members and the 23-36m Tesco Clubcard members.

Now, the risk is that Costco’s model tends to encourage “pantry‑load” shopping (large, less‑frequent shops). That reduces the number of shopping trips a household makes to traditional supermarkets, which can reduce the “impulse buys” that supermarkets rely on to generate higher margins. But the fees ensure revenue comes in even when they shoppers do not buy anything.

Let’s go back to the $1.50 hot dog/soda combo. Of course, it is not a profit driver, it is a loss-leader. But it is offset due to the fees. Consider that in 2008, the company deliberately brought production in house to keep the price point, going to the extent of building its own meat-processing plant. But this combo functions as a “value anchor” (or even part of the company’s moat) – reinforcing customers’ perception that Costco is deeply committed to value. That encourages loyalty, repeat visits, member renewals, and larger basket sizes during shopping trips.

Are things as rosy as they seem?

CostCo’s most recent full-year results (for the 12 months to the end of August 2025) showed US$269.9bn sales (up 8.1%), comparable store sales rising 5.9% nominally or 7.6% after adjusting for gasoline price changes and forex and e-commerce sales rose 15.6%. Its net income/profit was US$8.1bn, up from $7.4bn the year before and representing $18.21 per share. And Costco continues to expand its footprint: new warehouses are being added globally, helping drive both membership growth and sales growth.

Now of course, there are risks. Retailers like Costco all must manage rising costs (goods, shipping, tariffs), which can squeeze margins or force higher prices, risking member dissatisfaction. As a bulk-discount warehouse player, macroeconomic weakness might deter some consumers from bulk buying, although of course this can work both ways. Regulatory risks and scruitany are a risk too.

Competitors (other discount chains or online retailers) may also challenge market share. A challenge is that it relies heavily on consumers driving to the shops and stocking up their cars as opposed to a Coles Local or Woolworths Metro for people in the inner cities who don’t have cars. Maybe…just maybe…they go shopping too, and they just don’t know.

But the fact that CostCo is trying to expand beyond retail shows it is aware of the risk. Yes, these may be perceived as ‘add ons’ at its own outlets, but they encourage people to come for other reasons beyond grocery shopping. Most warehouses have gas stations often with discounted prices. They have pharmacy services, optical and hearing centres, food courts, and it even partners with travel companies to provide discounted vacation packages, cruises, rental cars and travel insurance.

There are future opportunities including in EV Charging, Healthcare services (aligning with Walmart Health and Amazon Care) and potentially co-branded credit cards.

Consensus estimates for FY26 call for US$297bn revenue and $20.07 EPS (up 10% and 11%). For FY27, $319.4bn revenue and $22.15 EPS (up 8% and 10%). The mean target price is US$1,056.50, up 17% from the current price. Despite the growth implied, the company’s multiples do not suggest it is cheap, placing the company at 44.6x P/E and 5.1x PEG. And of course, we know that shareholders can react negatively when companies miss consensus or guidance even if the bar was set high.

Conclusion

Costco is a company worth knowing about it. But is it a buy? Notwithstanding its high multiples, we think it is a unique company that warrants a premium over its peers given its business model.