Membership Fee Tailwind Delivers, Core-on-Core +29bps Broad-Based, FY26 Pipeline +30% — Upgrading to Outperform

Initial Read: The deferred-fee tailwind we held as the Q4 catalyst landed at the magnitude management framed; core-on-core margin expanded +29bps with breadth across all three categories; FY26 pipeline steps up 30%; and the stock pulled back on print — the conjunction we needed to upgrade.

Rating Action

This print upgrades from Hold (initiated Q2 FY25, maintained Q3 FY25) to Outperform.

• Q2 FY2025 (Initiating at Hold): Best-in-class franchise quality, but core-on-core margin compression (-8bps), tariff exposure unquantified, multiple already pricing continued operational beats — we wanted to see how 2H FY25 navigated.
• Q3 FY2025 (Maintaining Hold): Two near-term concerns retreated — core-on-core flipped to +36bps; tariff bracketed inside LIFO. But the largest known forward catalyst (Sept 2024 deferred-fee tailwind) was still ahead and priced. Held Hold pending Q4 confirmation.
• Q4 FY2025 (Upgrading to Outperform): The Q4 conditions for upgrade we held at Q3 cleared cleanly. (a) Membership fee income +14% Y/Y delivered the deferred-fee tailwind at exactly the magnitude framed, with Q1 FY26 still receiving the second-largest impact. (b) Core-on-core re-expanded +29bps with breadth across fresh, food/sundries, AND non-foods — structurally durable rather than commodity-deflation specific. (c) FY26 capex stepping up to fund 35 openings (+30%) with remodels, depots, manufacturing and tech all rising signals confidence in long-run unit economics. (d) Stock pulled back 2.3% on print despite the validation. The conjunction is what we needed: thesis-strengthening fundamentals into a softer relative price. We upgrade.

Sizing the Outperform. We do not chase parabolic moves but underwrite a 12-month total return above the S&P 500 from current levels. Path back to Hold runs through (a) sustained traffic deceleration below +3% worldwide, (b) Q1 FY26 deferred-fee landing materially below the second-largest-impact framing, or (c) tariff trajectory accelerating non-foods inflation enough to swamp the LIFO mechanism. Path to Underperform requires a renewal-rate slip below 92% US/Canada combined with a tariff-driven core-on-core margin reversal.

Results vs. Consensus

A clean operational beat across the board with the prior-year tax-benefit normalization framed transparently and the LIFO charge landing in line with management’s Q3 guide.

Worth bracketing: Q4 last year included a non-recurring $63M ($0.14/share) tax benefit from a transfer-pricing settlement and tax-reserve true-ups. Excluding that, both net income and EPS grew +14% Y/Y, which is the cleanest comparison. SG&A absorbed the lap of the July 2024 off-cycle wage increase for the first 10 weeks of the 16-week quarter (mid-to-high single-digit bps drag) plus the March 2025 employee agreement (mid-single-digit bps incremental). General-liability charges and reserves added ~5bps SG&A drag. Operations leverage and labor productivity offset partially — SG&A +9bps ex-gas vs. +17bps reported.

Segment / Geographic Performance

United States — Strong, Executive-Hours Tailwind

• US comp segment performance per the supplemental disclosure was the principal contributor to the total +5.7%; e-commerce +13.6% aggregate. The June 30 executive-only morning hours plus Saturday-evening hour delivered Vachris’s explicit ~1% lift to weekly US sales — a clean disclosure-quality data point.
• Record FY25 gas volumes (longer hours, new stations, expansions) drove low-single-digit gas volume positive in Q4 even as gas comps were negative mid-to-high single digits on lower per-gallon pricing.
• FY25 hot dog combos sold: >245M; rotisserie chickens: >157M; KS bath tissue volume that would reach the moon and back >200 times. The everyday-value flywheel is intact.

Canada and Other International — Quietly Strong

• Q4 FY25 international markets continued the all-positive-comp pattern from Q3, supported by FX flipping from headwind to slight tailwind (+0.2% to consolidated comps in Q4 vs. -1.2% in Q3).
• FY26 international warehouse pipeline accelerating: 2nd Sweden, 20th Korea, fill-in Canada all opened in Q4; FY26 plan implies meaningful continued international cadence.
• Localized KS production deepening: Asia laundry products (-40% prices in region), and now expanded examples cited including hot-dog production manufacturing investment and a new coffee roasting facility.

E-Commerce — Inflection Through Bullion Lap

• E-commerce comps +13.6% (+13.5% adj), in line with the Q3 framing of bullion and gift-card laps moderating prior-year double-digit prints.
• Site traffic +27% Y/Y — meaningfully above sales growth, suggesting continued conversion-rate runway as personalization and digital tools mature.
• Categories driving: gold/jewelry, housewares, apparel, tires, sporting goods, majors, small electrics, lawn/garden, domestics — all double-digit.
• Costco Logistics fifteenth consecutive quarter of improved member-experience scores; items delivered +13% Y/Y (decelerated from Q3’s +31%).
• New disclosure framework starting September 2025: e-commerce metric switching to “digitally enabled comparable sales” incorporating Instacart, Uber Eats, DoorDash, Costco Travel, and business-center delivery. FY25 digitally enabled sales >$27B — meaningfully larger than the $19.6B+ direct e-com number, and aligns COST’s reporting with peers. We treat this as analytically helpful but not thesis-relevant on its own.

Membership — Fee Income +14% Is the Print’s Headline

• Paid household members: 81.0M, +6.3% Y/Y.
• Cardholders: 145.2M, +6.1% Y/Y.
• Executive members: 38.7M, +9.3% Y/Y. Now 47.7% of paid base; 74.2% of worldwide sales (up from 47.3%/73.1% at Q3).
• Renewal rates: US/Canada 92.3% (-40bps Q/Q); worldwide 89.8% (-40bps Q/Q). Driven by Dec-2023 Groupon promo cohort entering the renewal calculation, plus continued digital sign-up share at lower renewal. Millerchip explicitly framed expectations of continued slight renewal-rate decline as digital sign-ups flow through.
• Younger member skew: “Almost half of new member sign-ups are now under the age of forty.” This is the strategic counterweight to the renewal-rate slip — younger digital-acquired members renew slightly lower but represent multi-decade lifetime-value runway.
• Membership fee income: $1.72B (+14.0%, +13.6% ex-FX). Sept 2024 US/Canada fee increase accounted for ~half of fee-income growth; excluding fee increase and FX, fee income +7% Y/Y on base growth + exec upgrades.

Key Topics & Management Commentary

Sept 2024 Membership Fee Increase — The Q4 Catalyst Lands

Millerchip’s prepared-remarks framing was the print’s most thesis-confirming sentence:

“Last September’s US and Canada membership fee increase accounted for a little less than half of the membership fee income growth in the quarter. Excluding the membership fee increase and FX, membership income grew 7% year over year.”
— Gary Millerchip, CFO

Translating: of the $212M Y/Y fee-income growth, ~$95-105M attributable to the price increase, ~$110-120M attributable to organic base-growth-plus-upgrades. Q1 FY26 receives the second-largest deferred-accounting tailwind per Millerchip’s prior framing — we model continued double-digit fee-income growth for at least the next two quarters before the year-over-year compares lap.

Asked by Bernstein’s Jiang Ma about sustainability of the underlying 7% ex-fee/FX growth, Millerchip pointed to (a) continued warehouse openings broadening geographic coverage, (b) younger digital sign-ups creating multi-decade LTV, (c) the ongoing exec-membership benefit additions accelerating upgrades. We accept this framing — the underlying fee-income compounding is structural.

Core-on-Core +29bps — Breadth Is the Story

Q3’s +36bps was driven primarily by fresh productivity and commodity-deflation tailwinds in butter/eggs/dairy. Q4’s +29bps is more important: fresh, food and sundries, AND non-foods all positive Y/Y. Drivers articulated:

• Supply-chain efficiency improvements in depots (gas helping operating cost there);
• Kirkland Signature penetration mix benefit (KS items typically 15-20% value vs. national brand);
• Fresh productivity and spoilage reduction continuing;
• Tariff drag on non-foods inflation absorbed in the $43M LIFO charge rather than core-on-core.

Millerchip’s framing on sustainability was again deliberately conservative — “we tend not to focus on individual quarters” — but the breadth across categories is what makes us more constructive than at Q3. This is the kind of margin compounding that defends the multiple over a multi-year horizon.

Tariffs: From Bracketed to Operationalized

Millerchip’s tariff framing has evolved meaningfully from “unquantified” (Q2) → “bracketed inside LIFO” (Q3) → “we largely feel like we’ve worked through the strategies that we needed to mitigate what we see in front of us today” (Q4). The specifics:

• Multipronged mitigation playbook: absorbed costs internally via efficiency/spoilage reduction; supplier consolidation savings of 30-40% on consolidated buys; country-of-origin shifts; localized regional production (KS Asia laundry -40%); item rotation toward higher-value KS alternatives; selective price pass-through on lower-elasticity discretionary items.
• 30% of business is international, providing flexibility to redirect tariffed-country sourcing to non-US markets.
• Vachris’s offensive posture: “We’re taking a very offensive approach to this. We’re going to do everything we can to mitigate tariff impacts. And the last effect would be we pass on price. And if we do that, we’re going to be the last one to go up and always the first one to go down on any opportunities we have out there.”
• Q4 FY25 LIFO charge $43M in line with the $40-50M Q3 guide; FY25 total LIFO ~$173M (vs. ~$145M Q3 estimate as inflation accelerated late in the year).

The residual risk is that the tariff trajectory steps up in FY26 — Millerchip explicitly flagged this as the principal swing — but the operational playbook is now demonstrated rather than aspirational. Thesis upgrade.

Executive Member Benefits Driving Upgrade Acceleration

The June 30 launch of executive-only morning hours, Saturday-evening hour expansion, and $10/month Instacart credit on $150+ baskets is the single most thesis-relevant strategic move of the year. The math:

• ~1% lift to weekly US sales from the new operating hours alone;
• Exec-member upgrade pacing accelerated meaningfully toward end of Q4 as the benefits were marketed;
• Exec-member share of paid base now 47.7% (vs. 47.3% Q3, 47.1% Q2) — on a base growing 6.3%.

This is the textbook flywheel move: COST is using ancillary partner economics (Instacart) plus operational design (hours that self-select for exec-tier members) to deepen the loyalty annuity at modest incremental cost. The SG&A absorption was minimal (operators offset via productivity), but the revenue/upgrade impact is structural. We expect this to compound through FY26.

FY26 Capex Steps Up — Confidence Signal

FY25 capex landed at ~$5.5B (above the $5.0B guided at Q2/Q3). FY26 capex framed by Millerchip as growing “again for the same reasons in ‘26 as ‘25” — meaning above sales-growth pace. Allocation drivers:

• 35 FY26 openings (5 relocations, ~30 net new) vs. 27 in FY25;
• Accelerated remodel pace (average US warehouse now ~20 years old);
• Depot expansion (manufacturing facilities including expanded hot-dog production, new coffee roasting);
• Land purchases for future depots;
• Technology investment for member experience and digital roadmap.

Asked by Baird’s Peter Benedict about long-run unit-growth runway, Vachris was constructive but disciplined: “We don’t strive for a number ... we’re not gonna make any bad decisions on opening warehouses to get to any set number.” The pace is opportunity-driven, not target-driven. International projects can take three years to fruition. The FY26 step-up is opportunity cresting, not a forced capex push.

Renewal Rate Trajectory — Cohort, Not Damage (Continued)

UBS’s Michael Lasser pressed Millerchip on whether renewal rates could revert to pre-COVID mid-to-high-80% worldwide levels. Millerchip’s response:

• The vast majority of the slip is attributable to higher digital-sign-up penetration as a share of new members.
• Younger digital members are net-positive (multi-decade LTV runway, larger overall base) but renew at slightly lower rates.
• Expect “a few more quarters of a similar type of impact” as cohorts continue to flow through.
• Strategic mitigation: invest in auto-renewal infrastructure, improve digital-engagement to drive younger members up the loyalty curve.

Our take: -40bps Q/Q (now 92.3% US/Canada) is consistent with the cohort-driven explanation. We watch for a sub-92% US/Canada print as a thesis-relevant warning sign but do not regard the current trajectory as thesis-breaking given the strong overall fee-income compounding.

Holiday Assortment — Strategic Pivot

Vachris’s holiday-assortment commentary was the most operationally concrete strategic move discussed:

• Thinned discretionary toy/decor/Christmas-tree assortment in response to tariff cost pressure;
• Replaced thinned categories with high-ticket non-traditional holiday goods: backyard sheds, garage saunas, furniture (none of which COST historically carried in the holiday window).
• This is the treasure-hunt model executing under stress: keeping member-relevance while dynamically reallocating limited SKU shelf to higher-margin, less-tariff-exposed categories.

Affirm BNPL, Retail Media, Card Refresh — Alternative Revenue Streams

Three updates on the alternative-revenue stack:

• Affirm BNPL launched Q3, “doing well” — no quantification offered.
• Retail media: Kimberly-Clark targeted MVM amplification campaign delivered 14:1 ROAS, +22% traffic to product detail pages, +45% digital sales on promoted items. Millerchip explicitly framed retail media as still in early stages of capability build, not yet a margin contributor.
• Co-branded credit card refresh: 5% rewards on gas added (was 4%); card design modernized; growth in program continues.

None of these is yet meaningful enough to model as an earnings line, but each contributes to the compounding member-engagement flywheel.

Outlook & Forward Commentary

Costco does not provide formal forward guidance. Actionable forward markers from the call:

Q1 FY26 setup: deferred-fee tailwind landing at second-largest impact, partial offset from continued LIFO drag if inflation persists, modest FX tailwind possible, exec-hours and Instacart-benefit lift annualizing through. We expect Q1 FY26 to comp at ~+5-6% reported / ~+6-7% adjusted with EPS in the high-single-digit Y/Y range — consistent with the multiple absorbing the tailwind without re-rating substantially higher.

Analyst Q&A — Notable Exchanges

• Christopher Horvers (JPMorgan) opened on the executive-hours rollout and the +1% comp lift sustainability. Vachris characterized the impact as well-established with continued runway as exec-benefit suite expands.
• Michael Lasser (UBS) drew the renewal-rate trajectory walk and the most candid acknowledgement that digital-cohort drag persists for several more quarters.
• Chuck Grom (Gordon Haskett) drew the broad-based core-on-core breakdown (fresh + food/sundries + non-foods all positive) and the holiday-assortment pivot to backyard sheds, saunas, furniture.
• Jiang Ma (Bernstein) probed the underlying 7% ex-fee/FX fee-income growth sustainability. Millerchip’s response on continued warehouse openings, younger digital sign-ups, and exec-member benefit additions was structurally supportive.
• Sherman (for Scott Ciccarelli, Truist) asked about credit-card-sharing-crackdown delayed benefits and exec-member mix shift — Millerchip dismissed the sharing-crackdown narrative and confirmed exec-member behavior more engaged + frequent.
• Simeon Gutman (Morgan Stanley) drew confirmation that Instacart/Uber business is growing strongly and the new digitally-enabled metric will surface that visibility starting Sept 2025 release.
• Peter Benedict (Baird) drew Vachris’s 35 openings + capex context: opportunity-driven, not target-driven; international projects three-year fruition cycle.
• Greg Melich (Evercore ISI) drew the inflation breakdown (consistent with Q3 at low-to-mid single-digits, non-foods now at low single-digit positive after twelve months deflation) and the credit-card refresh framing.
• Edward Kelly (Wells Fargo) got the most thesis-relevant Vachris response of the call — the offensive-posture framing on tariff mitigation: “Last to go up, first to go down.”
• Kelly Bania (BMO) probed long-run US household-membership penetration. Millerchip declined the explicit sizing but framed continued runway via new warehouses, fill-in markets, exec-benefit additions.
• Rupesh Parikh (Oppenheimer) drew confirmation that exec-hours lift is net-positive after the operator labor cost is netted, plus the alternative-revenue-stream framing (financial services + travel + retail media as multi-pronged).
• John Heinbockel (Guggenheim) drew the business-center growth framing — continued opportunity in Canada (now 6) and international, with relocated old buildings becoming business centers.
• Steven Zaccone (Citi) got the cleanest forward-cannibalization framing — expect continued similar headwind into FY26 as fill-in cadence persists.
• Oliver Chen (TD Cowen) closed with digital-roadmap and Kirkland Signature strategic-prioritization questions. Millerchip’s “no specific target” framing on KS reinforces the item-by-item-quality discipline established at Q2.

What They’re NOT Saying

• No formal FY26 EPS guidance. The capex acceleration is signaled but not the operating leverage on top — we model conservatively into Q1 FY26.
• No quantification of Affirm BNPL contribution. “Doing well” is the entire disclosure two quarters into the partnership.
• No quantification of Costco Next or retail-media revenue. Retail media still framed as “early stages” with capability investment not yet a revenue stream.
• No commitment on subsequent US membership fee increase timing. The Sept 2024 increase was the first since 2017 (seven-year gap vs. historical five-year cadence). Next increase timing remains an unaddressed forward variable.
• No explicit framing on the worldwide renewal-rate floor. “A few more quarters of decline” from current 89.8% leaves room for sub-89% prints we treat as the principal latent risk.
• No detailed discussion of e-commerce conversion-rate runway. Site traffic +27% Y/Y vs. e-com sales +13.6% — a 14-point gap suggesting conversion improvement is a priority but unsized.
• No discussion of capital return cadence. January 2024 $6.7B special dividend remains the most recent major action; FY26 capital-allocation framework left implicit.

Market Reaction

COST closed Friday September 26, 2025 down approximately 2.3% on a print where revenue beat, EPS beat, deferred-fee tailwind delivered, core-on-core re-expanded broadly, and FY26 capex stepped up. The reaction reflected the buy-side reading two soft signals through a premium-multiple lens: (1) worldwide traffic +3.7% versus +5.2% Q3 and +5.7% Q2 read as a deceleration trajectory; (2) two consecutive quarters of comp deceleration on adjusted basis (Q2 +9.1% → Q3 +8.0% → Q4 +6.4%) seen as a normalization warning. Volume was elevated; peer set (WMT, BJ, TGT) traded mixed.

The reaction is a textbook example of a high-multiple stock pulling back on optics rather than fundamentals. We read the same signals as the market read them, but with three offsets: (a) traffic moderation is partly a tough comp from Q4 FY24’s pre-fee-increase buying surge; (b) ticket on adjusted basis remains positive (+2.6% worldwide); (c) the membership-fee compounding plus exec-hours uplift delivered +14% fee-income growth that is the durable thesis driver. The 2.3% pullback is the dislocation we’ve been patient for. Upgrade.

Street Perspective

The bull case being made on the Street post-print converges on three planks: (1) membership fee income +14% Y/Y demonstrates the Sept 2024 increase is landing at the magnitude management framed, with Q1 FY26 still receiving the second-largest impact — this is contractual EPS upside that compounds; (2) core-on-core +29bps with breadth across all three categories defends the structural-margin-compounding thesis even as gas profitability declined; (3) FY26 capex step-up to fund 35 openings (+30%) signals confidence in long-run unit economics not visible in trailing comp data alone.

The bear case being articulated centers on: (1) traffic moderation from +5.2%/+5.7% to +3.7% worldwide is the canary on what was the cleanest underlying-momentum metric; (2) renewal rate down 40bps Q/Q at both US/Canada and worldwide, with Millerchip explicitly signaling continued slight decline — the loyalty-rate trajectory matters for the multi-decade LTV thesis; (3) capex acceleration with no formal margin-of-incremental-spend framework leaves the FCF-per-share trajectory more uncertain; (4) at ~50x forward earnings post-pullback, the multiple still discounts continued execution.

Our read sits on the bull side of (1)-(3) and pushes back on (1) of the bear case by attributing the traffic moderation partly to tough Q4 FY24 pre-fee-increase comp. On (2), we treat the cohort-driven slip as bounded above 92% US/Canada. On (3) and (4), we agree these are real but believe the post-print 2.3% pullback creates enough margin of safety. We are constructive.

Model Implications

• Q1 FY26 revenue: +5-6% reported, +6-7% adjusted on continued traffic stabilization plus FX modest tailwind; e-com (digitally enabled basis) double-digit on broader definition.
• Q1 FY26 gross margin: Modest Y/Y expansion as deferred-fee tailwind compounds and core-on-core stays positive across categories. LIFO charge dependent on FY26 non-foods inflation trajectory.
• Q1 FY26 SG&A: Wage headwind moderating as July 2024 lap fully behind; March 2025 lap continues; March 2026 +$1/hour increment incremental.
• FY26 EPS: Range moves to $20.50–$21.50 on Sept 2024 fee tailwind compounding plus exec-hours uplift annualizing. We model FY26 reported EPS conservatively below upper end given (a) FY26 LIFO uncertainty, (b) capex-driven D&A step-up, (c) tariff trajectory residual risk.
• FY26 fee income: Continued double-digit growth Q1-Q2 as deferred tailwind compounds; lapping into ~7% organic growth from H2 FY26.
• FY26 capex: $6.0–$6.5B base case on 35 openings + remodels + manufacturing + technology.
• Capital return: No special-dividend assumption modeled; modest buyback continuation in line with FY25 cadence.
• Tariff scenario: base case is FY26 LIFO ~$50–$100M depending on inflation trajectory; bear case $200M+ if tariff escalation accelerates non-foods inflation materially.

Thesis Scorecard

Action: Upgrading to Outperform. The deferred-fee tailwind we’ve been waiting for delivered at exactly the magnitude framed; core-on-core re-expanded with category breadth that suggests structural rather than commodity-cyclical compounding; FY26 capex acceleration signals confidence in long-run unit economics; and the stock pulled back 2.3% on print — the conjunction of fundamental strengthening into a softer relative price. We do not chase parabolic moves but underwrite a 12-month total return above the S&P 500 from current levels. Path back to Hold runs through (a) sustained traffic deceleration below +3% worldwide, (b) Q1 FY26 deferred-fee landing materially below management’s second-largest-impact framing, (c) tariff trajectory accelerating non-foods inflation enough to swamp LIFO, or (d) a renewal-rate slip below 92% US/Canada. We are constructive.