Costco's "Netflix Moment"

After the implementation of the ban on sharing membership cards, will Costco's rapid growth in membership numbers lead to a step up in revenue and profit?

On Tuesday, Morgan Stanley pointed out in a report that Costco is currently implementing membership scanners across the United States. Market research shows that this measure has brought a high conversion rate of members, with some Costco stores seeing double-digit growth in membership numbers, which will bring about growth effects similar to Netflix.

Costco's implementation of membership scanners is mainly to combat the sharing of membership cards. Similarly, in 2023, Netflix achieved 20 to 25 million new members in the first half of 2023 and 2024 by cracking down on password sharing.

It is worth mentioning that Costco, as a membership-based warehouse supermarket, derives most of its profits from membership fees, contributing nearly 70% of its net profit. Rapid growth in membership will undoubtedly increase Costco's revenue and profit.

Morgan Stanley estimates that in the 2025 fiscal year, under the base scenario, the membership scanner measure will result in an 8% increase in membership and a $0.54 increase in earnings per share; under the aggressive scenario, it will achieve a 12% increase in membership and a $0.82 increase in earnings per share.

Therefore, based on an expected earnings per share of $20.50 in 2026, Morgan Stanley rates Costco's stock as "hold" with a target price of $950, representing a 6% upside from Tuesday's closing price. Costco's stock price has risen by 34% so far this year.

Costco's implementation of membership scanners shows astonishing conversion of paid members

The full rollout of membership card scanners has led to surprisingly high conversion rates according to channel surveys. Morgan Stanley's channel survey shows,

During the testing phase, after the implementation of membership card scanners, the number of members at selected Costco stores increased by a low double-digit percentage, due to a significant conversion of non-paying customers. Membership card scanners are being rolled out in all Costco clubs in the United States.

Although the business models are very different, Netflix's experience can provide insights for Costco, as Morgan Stanley states:

In February 2023, before the restrictions were introduced, Netflix estimated that over 100 million non-paying households were "sharing" the membership eligibility held by approximately 231 million paying households, with an estimated 30 million non-paying households in the United States and Canada.

Due to measures to reduce password sharing, the exact revenue from paid sharing over the past five quarters cannot be determined. However, it is estimated that the company will see a net membership growth of 20 to 25 million in the first half of 2023 and 2024, with an additional 10 to 15 million potentially being "extra members."

Morgan Stanley's scenario assumptions for Costco show:

Costco's warehouse clubs in North America serve approximately 52 million members, about two-thirds of the global membership, including all levels (Gold Star, Business, and Executive). The base scenario suggests that Costco could gain an additional 4 million members by converting non-paying customers in North America, resulting in a discrete "boost effect" of about 5% to its total subscriber base of approximately 76 million globally

For every 1% increase in members, there is a 0.37% increase in earnings per share

In terms of profitability impact, Morgan Stanley pointed out that increasing the number of members by 1 percentage point will result in approximately 0.37% growth in operating profit and earnings per share (EPS).

Compared to the company's overall 53/47 ratio, it is conservatively assumed that non-paying customers will convert to paid members at an 80/20 non-executive/executive ratio. Since membership fee income (MFI) accounts for slightly more than half of Costco's bottom line, the rule of thumb is that for every 1 percentage point increase in members, there will be approximately 0.37% growth in operating profit and earnings per share (EPS).

In a conservative scenario, membership will grow by 4% in the 2025 fiscal year, resulting in a $0.54 increase in earnings per share; in the base scenario, membership will grow by 8%, also leading to a $0.54 increase in earnings per share; in the aggressive scenario, achieving a 12% increase in members will result in an $0.82 increase in earnings per share.

Membership conversion is crucial. In a more optimistic scenario, Morgan Stanley assumes that non-paying customers will convert to paid members at the same rate as the company's overall 53/47 ratio. In this case, for every 1 percentage point increase in members, there will be approximately 0.46% growth in operating profit and earnings per share (EPS).

Furthermore, Costco raised its membership fees in September, but the impact on financial statements will gradually materialize over the next 24 months, with an expected peak in the first quarter of 2026, as the fee increase is being rolled out.

What is Costco's upside potential?

Morgan Stanley rates Costco's stock as "overweight" with a target price of $950, based on an expected EPS of $20.50 in 2026. This valuation method includes a historical price-to-earnings ratio and enterprise value multiple framework, highlighting Costco's defensive growth and robust fundamentals.

Bernstein analyst Zhihan Ma has initiated coverage on Costco with an "outperform" rating for the first time, setting a target price of $1,016, implying a 15% upside potential for the stock.

Zhihan Ma acknowledges that Costco's valuation is high, with a price-to-earnings ratio of 50 times, far above the industry average of around 14 times. However, she believes that the company continues to deliver strong sales and profit growth year after year, providing additional upside potential for its stock price.

Today, American ordinary shoppers are very value-conscious, meaning they will increasingly turn to retailers that offer "attractive everyday groceries."

At the same time, Costco's business model also helps the company stand out. The simple, self-service warehouse model makes Costco more productive than its mass-market retail counterparts, with a wide variety of products - including the popular Kirkland private label, gold bars, and other high-quality products, which will inspire customer loyalty