Comps Strong, EPS Light, Tariff Overhang at Full Valuation — Initiating at Hold
Initial Read: A revenue beat with an EPS miss, healthy adjusted comps, and a tariff overhang management cannot quantify — against a multiple that already prices in best-in-class execution. We initiate at Hold.
Key Takeaways
- Rating: Initiating at Hold. Costco is best-in-class on every operating metric we track — renewal rates, traffic, executive-member penetration, Kirkland Signature momentum — but the print exposed three near-term headwinds (core-on-core margin compression, a March wage step-up, an unquantified tariff exposure on roughly a third of US sales) into a multiple that already capitalizes the long-run franchise. We want to see how management navigates 2H FY25 before paying up.
- Top line very healthy; mix is the story. Total comps +6.8% (+9.1% adjusted for FX and gas deflation), US comps +8.3%, Canada comps adjusted +10.5%, other international adjusted +10.3%, e-commerce +20.9% (+22.2% adj). Worldwide traffic +5.7%; US traffic +5.6%. Non-foods led with mid-teens comps; gold/jewelry, gift cards, toys, housewares, appliances, sporting goods, home furnishings, and small electrics all double-digit. The franchise is gaining wallet share through value perception even as inflation creeps back.
- Membership engine is intact and accelerating. Membership fee income $1.193B (+7.4%, +9.4% ex-FX); the September 2024 fee increase contributed ~3% of fee income this quarter, with the largest deferred-accounting benefit still ahead in Q4 FY25 and Q1 FY26. US/Canada renewal 93.0%; worldwide renewal 90.5%. Paid household members 78.4M (+6.8%); cardholders 140.6M (+6.6%); executive members 36.9M (+9.1%), now 47.1% of paid members and 73.8% of worldwide sales. The annuity is compounding.
- Margin walk is mixed; watch core-on-core. Reported gross margin +5bps (+4bps ex-gas). But core-on-core margin was −8bps on supply-chain investment (higher inventory build) and non-foods mix shifts — this is the line item that historically drove the beat-and-raise template. SG&A leveraged +8bps (+9bps ex-gas) on operations productivity. The new employee agreement that took effect this week creates a 13bps gross SG&A headwind from March 3rd, partially offset by lapping prior wage actions for a net mid-single-digit bps headwind Q3 onward. Margin compounding is paused, not reversed — but it is paused.
- Tariff is the principal unquantified risk. About a third of US sales are imported; less than half of that comes from China, Mexico, and Canada combined — meaningful, not catastrophic. Vachris flagged the firm’s flexibility on supplier substitution and pricing pass-through but explicitly declined to size the impact given how fluid policy is. The downside scenario in which Costco is forced to absorb a meaningful share to defend price perception — consistent with its stated value-first posture — is a real EPS risk we cannot bracket from the call.
- Stock reaction is the tell. COST closed −6.1% on March 7, the largest single-day drawdown since December 2022. The market is reading the same signals we are: the print is a reset of the run-rate beat-and-raise expectation against a full multiple. We do not initiate buy-the-dip on a stock that has compounded through a 30-bagger; we initiate at Hold and wait for either valuation reset or a quarter that re-establishes core-on-core margin expansion.
Rating Action
This is our initiating coverage report on Costco Wholesale. We are Initiating at Hold.
- Why Hold and not Outperform. Costco is one of the highest-quality businesses in the public-equity universe by our framework — member-funded operating leverage, low-SKU velocity model, ~93% US renewal, executive penetration approaching half the membership base, Kirkland as a margin and loyalty flywheel. None of that is in dispute. What is in dispute is whether the current multiple ~50x forward EPS leaves enough margin of safety for a sub-S&P-500 12-month return scenario in which: (a) core-on-core margin remains under modest pressure on supply-chain build and Kirkland mix, (b) wage investment runs at a net mid-single-digit bps headwind through Q3, and (c) tariffs require either gross-margin absorption or partial price increases that lean against the value brand. We can underwrite the long-term compound; we cannot underwrite that the next 12 months beat the index from this entry point.
- Why Hold and not Underperform. The franchise is not breaking. Renewal at 93.0% US/Canada, traffic +5.7% worldwide, e-commerce +20.9%, executive membership +9.1%, the deferred fee tailwind still ahead — these are not numbers that support a structural-impairment thesis. The bear case requires either a discrete event (recession, sustained tariff absorption) or a multiple compression we cannot time. Hold is the honest call.
- Path to Outperform. A combination of (i) core-on-core margin re-expansion, (ii) tariff impact bracketed and proven manageable, (iii) the deferred membership-fee tailwind landing at the magnitude management has signaled (largest impact Q4 FY25 / Q1 FY26), and (iv) any meaningful valuation reset would move us constructive.
- Path to Underperform. Sustained core-on-core margin compression beyond two quarters, a tariff scenario in which COST absorbs >50bps of gross margin, or a renewal-rate slip below 92.5% US/Canada would drive a downgrade.
Results vs. Consensus
The headline is a small EPS miss against a clean revenue beat — but the composition is more nuanced than the print suggests, with the tax-rate normalization and FX translation drag both worth flagging.
| Metric | Q2 FY25 Actual | Y/Y | Consensus | Color |
|---|---|---|---|---|
| Net Sales | $62.53B | +9.1% | ~$63.13B | Beat (using total revenue $63.72B incl. membership) |
| Total Revenue | $63.72B | +9.1% | ~$63.13B | +0.9% above |
| Diluted EPS | $4.02 | +2.6% reported / +8.4% adj | ~$4.09 | ~$0.07 miss; prior-year had $0.21 tax benefit |
| Total Comp Sales | +6.8% / +9.1% adj | n/a | ~+6.5% | Strong on adjusted basis |
| US Comp Sales | +8.3% / +8.6% ex-gas | n/a | ~+8% | Solid traffic-led |
| E-commerce Comps | +20.9% / +22.2% ex-FX | n/a | n/a | Inflection continuing |
| Membership Fee Income | $1.193B | +7.4% / +9.4% ex-FX | ~$1.20B | In line; deferred tailwind ahead |
| Gross Margin (reported) | 10.85% | +5bps | n/a | Up; core-on-core down 8bps |
| SG&A Rate | 9.06% | −8bps (better) | n/a | Operations productivity |
| Operating Income | n/a | +12.3% | n/a | Cleanest single metric |
Worth bracketing: prior-year EPS included a $94M ($0.21/share) discrete tax benefit from the special-dividend deductibility for 401(k) participants. Excluding that, both net income and EPS grew +8.4% Y/Y. The reported tax rate of 26.2% (vs. 22.1% LY) is a clean Y/Y comparison once that item is normalized. FX translation cost ~$57M ($0.13/share) Y/Y; interest income drag was another ~$70M Y/Y on lower cash balances post-special-dividend and lower rates. Cleanly framed: operating income +12.3% Y/Y is the headline that matters.
Segment / Geographic Performance
United States — Strong, Traffic-Led
- US comp sales +8.3% (+8.6% ex-gas deflation). Traffic +5.6%; ticket +2.6% reported (+2.8% adjusted).
- Strongest US regions: Midwest, Northeast, Los Angeles. Strong execution against weather headwinds management called “the same weather everybody else did” without sales loss attributable to it.
Canada — Standout
- Reported comp +4.6%; adjusted for gas deflation and FX, +10.5% — the strongest of the three reporting regions on an adjusted basis. Vachris explicitly flagged Canada as having delivered “record results on a constant currency basis.”
- FX created an approximate 6% headwind in February alone on the Canadian unit. Constant-currency dynamics remain a tailwind to the underlying business.
Other International — Healthy Adjusted
- Reported comp +1.7%; adjusted +10.3%. February stepped down on a Chinese New Year timing shift in Korea and Taiwan that management explicitly flagged as needing to be averaged with January for a clean read.
- FX drag in February: ~7% headwind on other international.
- Strongest other international markets in February: Mexico, Taiwan, Korea.
E-Commerce — Inflection Continuing
- E-commerce comps +20.9% (+22.2% ex-FX). Bullion was a meaningful contributor; home furnishings, small electrics, hardware, sporting goods all up double-digits.
- Costco Logistics delivered a record holiday season with >500,000 deliveries, growing share in big-and-bulky.
- Costco Next (curated marketplace) had record holiday sales, approaching ~100 vendor sites with significant AOV growth.
Membership — The Annuity Compounds
- Paid household members: 78.4M, +6.8% Y/Y.
- Cardholders: 140.6M, +6.6% Y/Y.
- Executive members: 36.9M, +9.1% Y/Y. Now 47.1% of paid base; 73.8% of worldwide sales.
- Renewal rates: US/Canada 93.0%; worldwide 90.5%. Both at or near all-time highs.
- Membership fee income: $1.193B (+7.4% reported, +9.4% ex-FX). Sept 2024 fee increase contributed ~3% of fee income; deferred-accounting tailwind is loaded toward Q4 FY25 / Q1 FY26.
Key Topics & Management Commentary
Tariffs: Flagged but Not Quantified
Vachris’s framing was the call’s most market-relevant comment, given the early-March policy fluidity:
“About a third of our sales in the US are imported from other countries, and less than half of those are items coming from China, Mexico, and Canada. ... Our team remains agile, and our goal will be to minimize the impact of related cost increases to our members.”
— Ron Vachris, CEO
Asked specifically by Truist’s Scott Ciccarelli whether tariff exposure would prompt aggressive supplier-country substitution or stoic absorption, Vachris answered “a little bit of both,” citing the treasure-hunt SKU model and the firm’s reduced-SKU buying flexibility. Read-through: management explicitly declined to size the EPS impact, which is appropriate given fluidity but does mean tariffs become an unbracketed near-term overhang on the model. Our base case is that COST absorbs a portion to defend value perception; the magnitude is the variable to watch in Q3 FY25.
Wage Investment: 13bps Headwind, Net Mid-Single-Digit After Lap
The new employee agreement, effective the week of the call, creates a meaningful but pre-disclosed SG&A pressure:
- $1/hour top-of-scale increase immediately, with another $1 in March 2026 and again in March 2027.
- Bottom-of-scale wage to $20/hour (+$0.50).
- US service-clerk top-of-scale wage now $31.90/hour; average wage including hourly >$31/hour.
- Sixth week of vacation after 30 years of service.
Millerchip quantified the impact precisely: 13bps gross SG&A headwind from March 3 onward, but with the prior-March wage action lapping, the net Y/Y headwind is mid-single-digit basis points. Q3 FY25 will additionally absorb a one-time vacation-accrual catch-up to the start of fiscal year. This is a known cost; what matters is whether operations productivity continues to offset, which it did this quarter at +9bps SG&A leverage on the core.
Core-on-Core Margin: Flagged for the First Time
The call’s most analytically important line item. Reported gross margin was +5bps, but Millerchip volunteered the underlying core-on-core was −8bps:
“This decline was due to investments in supply chain to support higher inventory and some mix changes in our non-food categories. ... I wouldn’t really read too much into the individual results in the quarter on the core-on-core margin. Overall, we were pleased with the fact that the gross margin rate was up four basis points.”
— Gary Millerchip, CFO
UBS’s Michael Lasser pressed on whether this signaled an end to the multi-year margin-expansion arc. Millerchip’s response was a deliberate “don’t over-read” framing alongside an acknowledgment that food and sundries was up slightly, fresh up slightly, and non-foods down slightly — mix-driven. Our read: a quarter of core-on-core margin compression is not a thesis-breaker, but it is the canary on the beat-and-raise template that has anchored COST’s premium multiple. We want to see Q3 FY25 reverse this before treating it as cyclical noise.
Kirkland Signature: Still Compounding
Vachris was emphatic that Kirkland continues to grow faster than the company overall, with two new strategic moves disclosed:
- KS diapers reworked with a new supplier — longer/thicker absorbent layer, softer outer cover, 2x more waistband stretch — with an 11% value increase for the member.
- New launches: KS French fries, KS vodka and soda, KS Lager.
- Localized production: KS purified water for China produced in-country, delivering >20% savings versus the prior branded offering.
Asked by Guggenheim’s John Heinbockel about the cadence of new KS introductions, Vachris was disciplined:
“We’re not in a race to develop hundreds of Kirkland items. We look at it more of a strategic item-by-item basis ... we hold Kirkland Signature to the same standards we would [for] any branded item. If the sales are not performing, our members are not resonating with that item, it is as quick to go out as any branded item would be.”
— Ron Vachris, CEO
This is the right philosophy — Kirkland as a margin-and-loyalty flywheel rather than a SKU-proliferation strategy. The 11% value-increase on diapers is the kind of detail that compounds member-trust capital over years.
Big-Ticket Discretionary — Treasure Hunt Working
Non-foods led with mid-teens comps. The standout categories:
- 98- and 100-inch TVs, Stern pinball machines, gaming computers — all strong over holiday.
- Gold and jewelry, gift cards, toys, housewares, appliances, sporting goods, home furnishings, small electrics — all double-digit.
Consumer electronics overall was characterized as “flat to slight growth” with the category waiting for “the next wave of new innovation.” Apparel similarly slow-moving. Our read is that COST is gaining unit share in a softer category and the holding pattern is industry-driven, not COST-specific.
Membership Fee Increase Pacing
The September 2024 US/Canada fee increase contributed ~3% of fee income this quarter. Millerchip flagged that the deferred-accounting majority of the benefit lands over the next four fiscal quarters with the largest impact in Q4 FY25 and Q1 FY26. This is the principal known tailwind to the FY26 EPS bridge. Internationally, fee increases are out of phase: Australia (FY23), Mexico (Sept 2024), and now Japan and Korea announced this quarter.
Costco Logistics, Costco Next, and Retail Media
- Costco Logistics: record holiday season >500,000 deliveries.
- Costco Next: ~100 vendor sites, record holiday sales, significant AOV growth.
- Retail media: ~10 partner campaigns now live following the Q1 first off-site launch. Millerchip explicitly framed retail media not as a new high-margin revenue stream but as funding to reinvest in member value — a deliberate philosophical departure from peer playbooks.
- Co-branded credit card: executive members now earn 4% cashback (up from 2%) on the majority of purchases, with 5% on Costco gas (last quarter).
Inflation Re-emerging
Overall low-single-digit inflation in the quarter, vs. flat last quarter. Fresh was the most inflationary, led by meat and bakery (eggs in particular). Food and sundries low-single-digit inflation. Non-foods deflationary versus prior, evening out as supply-chain deflation laps. The inflation trajectory matters for ticket dynamics — the basket has been growing on items rather than inflation, and a resumption of inflation could drive optical comp acceleration without underlying unit acceleration.
Outlook & Forward Commentary
Costco does not provide formal forward guidance. The call surfaced the following actionable forward markers:
| Forward Item | FY25 Color |
|---|---|
| FY25 capex | ~$5B (vs. $1.14B in Q2) |
| FY25 new openings | 28 gross (3 relocations) for 25 net new buildings; 15 US + 3 Canada + 7 other international |
| FY25 tariff impact | Unsized; ~1/3 of US sales imported, <1/2 of that from China/Mexico/Canada |
| FY25 wage headwind | 13bps gross SG&A from March 3; net mid-single-digit bps Y/Y after lap |
| FY25 FX translation | Continued headwind expected through year-end |
| Membership fee deferred tailwind | Largest impact Q4 FY25 and Q1 FY26 from Sept 2024 increase |
| February sales (March 2 reset) | Total comps +6.5%; adj +8.3%; e-com +19% (+20.2% adj); traffic +5.0% WW / +5.8% US |
The lack of formal guidance is by design and we do not penalize for it. What matters is that the qualitative signals on tariffs and wages are uncomfortable in the same direction, while the membership-fee tailwind is loaded into the back half of the fiscal year. The setup favors a Q3 FY25 print where the question is whether core-on-core margin re-expanded.
Analyst Q&A — Notable Exchanges
- Simeon Gutman (Morgan Stanley) opened with the consumer-state question and tariff backlash in Canada specifically. Millerchip’s response was that members remain quality/value/newness-focused with willingness to spend but are increasingly “choiceful”; food-at-home gaining share over food-away-from-home; Canada strong even before adjustment.
- Michael Lasser (UBS) pressed on whether core-on-core margin compression signaled an end to the multi-year expansion arc. Millerchip explicitly declined to extrapolate from a single quarter, citing supply-chain investment and non-foods mix shifts.
- Christopher Horvers (JPMorgan) probed weather impact on February (limited; recovered) and the firm’s stance on passing through fresh-food tariffs. Vachris’s response on supplier mitigation was clean but uncommitted on price-pass-through magnitude.
- Scott Ciccarelli (Truist) asked about treasure-hunt flexibility on tariffed China/Mexico/Canada categories — response: “a little bit of both” (substitution and absorption).
- Jiang Ma (Bernstein) probed February international slowdown (Chinese New Year timing) and long-term international warehouse growth (~half of 25-30 annual openings to be international).
- Oliver Chen (TD Cowen) asked about consumer electronics health (flat-to-slight growth, gaining share in soft category) and personalized digital MVM efficacy (early but encouraging).
- John Heinbockel (Guggenheim) drew the most strategically relevant Vachris answer of the call on Kirkland Signature category-by-category development discipline.
- Rupesh Parikh (Oppenheimer) got the cleanest framing of the wage headwind math (13bps gross / mid-single-digit net).
- Greg Melich (Evercore ISI) drew the inflation breakdown (fresh highest, food/sundries low-single-digit, non-foods evening out from prior deflation) and the retail-media philosophy framing (reinvest, not new revenue stream).
- Edward Kelly (Wells Fargo) pressed on store-throughput and gas-station hour expansion; Vachris flagged checkout speed as a primary technology focus.
- Chuck Grom (Gordon Haskett) asked about the digital MVM and personalization — ~40M emails reaching members; first personalized iteration this month (February); incremental to mailed MVM, not replacing it.
- Kelly Bania (BMO) drew the international fee-increase cadence (Australia FY23, Mexico Sept 2024, Japan and Korea announced this quarter) and exec-membership maturity walk (US/Canada highest, Asia next, Australia/UK behind Asia).
- Robbie Ohmes (Bank of America) got the basket-growth dynamics framing (last twelve months saw items-per-basket turn from flat-to-negative into positive on non-foods strength; inflation now adding to that).
- Joe Feldman (Telsey) drew the gas-volume clarification (February down, but YTD positive; market flat-to-down with COST gaining share).
- Mike Baker (DA Davidson) closed with the gas-hour-extension efficacy (early but encouraging member usage uptick) and price-gap framing (proactive, not reactive; market-rate confidence).
What They’re NOT Saying
- No quantification of tariff impact. Management acknowledged ~1/3 of US sales imported with <1/2 of that from China/Mexico/Canada, but explicitly declined to size the EPS or margin impact. Appropriate given fluidity, but creates an unbracketed near-term overhang.
- No defense of the core-on-core margin number. Millerchip’s response to Lasser was “don’t over-read,” not “here is why this reverses next quarter.” The absence of a forward bridge is itself signal — mix and supply-chain investment are likely persistent factors in 2H FY25.
- No formal capex breakdown. $5B FY25 capex was reaffirmed but the split across new clubs, IT/digital, and supply chain was not laid out. With Costco Next and Logistics scaling materially, the IT/digital share is likely above historical norm.
- No specific commentary on a special dividend. The January 2024 $6.7B special dividend rolled off the lower-cash-balance comp this quarter, but no forward signaling was offered on whether another special is contemplated. Capital-return cadence is a known overhang we’ll watch.
- No update on US membership fee further increases. The September 2024 increase is fresh and the deferred-accounting tailwind is the FY25/FY26 story; international fee increases were the focus this quarter.
Market Reaction
COST closed Friday March 7, 2025 down approximately 6.1%, the largest single-day decline since December 2022. Volume was elevated. Peer set (WMT, TGT, BJ) traded mixed; the move was idiosyncratic to COST rather than a sector decompression. Buy-side commentary on the day clustered around three concerns: (1) the EPS miss against an already-reset multiple expectation; (2) Vachris’s tariff framing being more open-ended than risk-averse holders preferred; (3) the core-on-core margin compression read as the first crack in the beat-and-raise template that has supported the premium multiple.
The reaction is consistent with a stock that prices in best-in-class execution and reacts violently to anything that questions whether execution remains best-in-class. The fundamentals do not support a structural-impairment narrative, but the multiple does require continued operational beats — and this print delivered an operational pause.
Street Perspective
The bull case being made on the Street post-print converges on three planks: (1) the membership-fee deferred tailwind landing in Q4 FY25 / Q1 FY26 is large and contractual; (2) Canada and other international adjusted comps in the +10% range demonstrate the international growth runway is real with similar-or-better unit economics than the US; (3) the e-commerce/Costco Logistics/Costco Next stack is finally compounding off a meaningful base, with +20.9% e-com comps and 100 vendor sites on Next.
The bear case being articulated centers on: (1) the multiple discounts continued operational beat-and-raise, and core-on-core margin compression is the first observable fissure; (2) tariffs are an unbracketed downside scenario in which COST’s value-first DNA forces gross-margin absorption rather than price pass-through; (3) the wage-investment cadence is now structurally stepped up through 2027, capping operating-margin expansion absent productivity offsets that may already be at the asymptote; (4) the consumer-electronics and apparel categories are genuinely soft — gaining share in a flat industry isn’t the same as growing.
Our read sits on the bear side of (1) and (2) and the bull side of (3). On (4), we agree the categories are soft but do not regard it as thesis-relevant given the breadth of double-digit non-food strength elsewhere.
Model Implications
- FY25 revenue: Q2 +9.1% Y/Y combined with February +8.8% supports a base case in the high-single-digit-percent range for the balance of FY25, with constant-currency growth materially higher.
- FY25 gross margin: We model flat-to-modestly-up reported gross margin with core-on-core staying modestly negative through Q3 FY25 before reverting in Q4 FY25 as the membership-fee tailwind compounds.
- FY25 SG&A: Net mid-single-digit bps wage headwind from Q3, partially offset by operations productivity. We are skeptical the firm fully offsets the wage step-up in Q3 alone given the vacation-accrual one-time catch-up.
- FY25 operating margin: Roughly flat Y/Y, with the membership fee deferred tailwind providing the principal upside risk in Q4 FY25.
- FY25 EPS: We model in the $17.30–$17.80 range, against a current-implied multiple in the high-50s on consensus.
- FY26 EPS: Membership-fee tailwind plus continued comp acceleration suggests upside to $20+ EPS, but the tariff scenario is the principal swing.
- Capex: $5B FY25 base case; we treat upside risk to ~$5.3–$5.5B as Costco Next and Logistics infrastructure scales.
Thesis Scorecard
| Thesis Point | Status | Notes |
|---|---|---|
| Bull #1: Membership annuity compounds, fee deferred tailwind drives FY26 bridge | Confirmed | Sept 2024 fee +3% contribution this Q; largest deferred impact Q4 FY25 / Q1 FY26 |
| Bull #2: International unit economics underwrite multi-year warehouse runway | Confirmed | Canada +10.5% adj; Other Intl +10.3% adj; ~half of 25-30 annual openings international |
| Bull #3: E-commerce / Logistics / Next compound past the inflection | Confirmed | E-com +20.9%; Costco Logistics record holiday; Next ~100 vendors |
| Bull #4: Kirkland Signature is a flywheel, not a SKU race | Confirmed | Diapers reworked +11% value; KS purified water China localized -20%; growing faster than total |
| Bear #1: Core-on-core margin compounding pause challenges the beat-and-raise multiple | Active | Core-on-core −8bps; supply-chain investment + non-foods mix; not yet reversed |
| Bear #2: Tariff exposure on ~1/3 of imported US sales is unbracketed | Active — Latent | Vachris declined to size; default risk is partial absorption |
| Bear #3: Wage cadence stepped up through 2027 caps operating-margin expansion | Active | Net mid-single-digit bps headwind Q3 onward; productivity offsets to be tested |
| Bear #4: Multiple already discounts the long-run franchise | Active | ~50x forward EPS leaves limited margin of safety |
Action: Initiating at Hold. The franchise is best-in-class; the multiple is full; the print introduced two near-term frictions (core-on-core, tariffs) without bracketing them. Path to Outperform runs through a clean Q3 FY25 with re-expanded core-on-core and a tariff impact bracketed at <30bps gross-margin absorption. Path to Underperform requires sustained core-on-core compression or a renewal-rate slip below 92.5% US/Canada. We expect to be patient through Q3 before changing the rating.