Core-on-Core Slips, Membership-Fee Tailwind Normalizes, Member Growth Cools — Downgrading to Hold as the Re-Rating Runs Its Course

Rating Action

This print downgrades COST to Hold from the Outperform we moved to at Q4 FY25. The downgrade is a risk/reward judgment, not a verdict on the quarter — the quarter was good. Our Outperform was a re-rating call anchored on three identifiable levers, and two of the three have now run their course while the third (a valuation entry point) has closed.

• Q2 FY2025 (Initiating at Hold): Best-in-class franchise quality, but core-on-core compression (-8bps), unquantified tariff exposure, and a 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 (the Sept-2024 deferred-fee tailwind) was still ahead and already priced. Held pending Q4 confirmation.
• Q4 FY2025 (Upgrading to Outperform): Deferred-fee tailwind delivered at +14%; core-on-core +29bps with category breadth; FY26 capex stepped up; the stock pulled back 2.3% on the print despite the validation. Fundamental strengthening into softer relative price — we upgraded.
• Q1 FY2026 (Maintaining Outperform): Fee income compounded +14% for a second quarter; core-on-core +30bps broad-based; renewal slip moderated to -10bps Q/Q. We noted the thesis had shifted into “execution mode rather than re-rating mode” and warned holders to reassess sizing if the stock pushed through the upper end of fair value without a corresponding thesis upgrade.
• Q3 FY2026 (Downgrading to Hold): The deferred-fee tailwind has normalized (fee income +10.7%, the Sept-2024 contribution roughly halved); the broad-based core-on-core expansion reversed to -9bps; total member growth cooled to +4.1%; and the stock trades at ~50x forward only ~9% off its high. The bull case is now “steady-state compounding at a premium multiple,” which is a Hold, not an Outperform. We are not waiting for a thesis break — we are acknowledging that the specific catalysts we underwrote have been delivered and harvested. Franchise intact; valuation no longer leaves margin of safety. Hold.

Results vs. Consensus

Consensus EPS shown at the 30-analyst $4.92 aggregate; some desks modeled as high as $4.98, against which the print is a slight miss. Gross-margin “miss” is reported rate; ex-gas inflation the rate was +1bp Y/Y. Net sales vs. total-revenue consensus is the apples-to-oranges that produced “mixed/revenue miss” headlines at some outlets.

Year-over-Year Comparison

Assessment — Revenue

Net sales of $69.2B grew 11.6%, but the composition matters more than the number. Gas-price inflation (+2.2% to comps) and FX (+1%) accounted for the bulk of the gap between the +9.8% reported comp and the +6.6% ex-gas/FX comp. Record gasoline volumes — driven by Middle East supply disruption that pushed pump prices up and sent value-seeking members to Costco stations — inflated the top line in a way that is real cash but neither high-margin nor structural. The cleaner read is the +6.6% ex-gas/FX figure, which management noted has barely varied in a year. Total revenue (including the $1.37B of high-margin membership fees) of ~$70.5B beat the ~$69.8B Street figure; the “revenue miss” some outlets ran reflects comparing $69.2B net sales against a total-revenue consensus, not a genuine shortfall.

Assessment — Margins

Reported gross margin fell 21bps to 11.04%, but ex-gas inflation it rose 1bp — the gas-mix drag (gas, e-commerce and pharmacy all growing faster than core merchandise) mechanically depresses the reported core rate. The number the bears will seize on is core-on-core -9bps, the first negative reading after +36 / +29 / +30bps. Management was unambiguous that this was a decision: with last year’s $130M LIFO charge rolling off (only $44M this year), they elected to push price investment into eggs and beef precisely while members were absorbing higher gas costs. SG&A told the mirror-image story: reported rate improved 20bps, but ex-gas the operations component actually delevered 3bps as healthcare-cost inflation and a couple of one-time items (legal settlements/reserves in central) overwhelmed mid-single-digit core productivity. Neither line is alarming on its own; together they say the margin-expansion tailwind that powered the upgrade has, for now, stopped expanding.

Assessment — EPS

EPS of $4.93 (+15.2%) is the cleanest-looking line and the most flattered. Below the operating line, interest income rose to $130M (from $95M) on a larger cash balance, FX-and-other swung to a $25M benefit from a $10M loss, and the tax rate fell 80bps to 25.4%. Those three below-the-line items contributed a meaningful slice of the 15% growth; operating income growth was the more pedestrian story given the flat-to-down core margin. We would underwrite forward EPS growth in the high-single to low-double-digit range as the deferred-fee tailwind fully laps and gas normalizes — not the 15% the headline implies.

Segment & Category Performance

Costco does not report profit by merchandise category, but the comp-by-category disclosure is the cleanest window into where demand is concentrating. The pattern this quarter: discretionary non-foods and ancillary (pharmacy, gas) ran hottest, core food categories were steady, and the basket is broadening into self-care and protein.

Membership — the annuity, now off peak tailwind

Membership fee income of $1.37B grew 10.7% (9.9% ex-FX), a clear step down from the +14% of the prior two quarters. The deceleration is mechanical and was telegraphed: the September 2024 US/Canada fee increase, which contributed roughly half of fee growth at its peak, now contributes “a little more than 1/4.” Underlying growth ex-fee-increase and FX held at +7%, driven by base growth and executive upgrades.

“The September 2024 US and Canada membership fee increase accounted for a little more than 1/4 of membership income growth. Excluding the membership fee increase and FX, membership income grew 7% year over year.” — Gary Millerchip, CFO

Assessment: The annuity is intact and still compounding at ~7% underlying, but the accounting tailwind that supercharged the last three prints is now mostly behind us. From here the fee line grows with the member base and executive mix — a good but unremarkable mid-single-digit story until the next fee increase. This is the single clearest reason the “re-rating” phase is over.

Gas — record volumes and the loyalty flywheel

Gas was the quarter’s swing factor. Middle East supply disruption pushed pump prices and price sensitivity higher; Costco widened its price gaps to stay the value leader, and volumes hit all-time records — every 4-week period set a successive company record, and the final five weeks were the top-five volume weeks ever. Critically, many members used a Costco station for the first time.

“The high consumer price sensitivity, which fueled these record volumes, also drove many members to use our gas stations for the very first time… members who use our gas stations typically spend more with us in the warehouse.” — Ron Vachris, CEO

Assessment: Gas is the right kind of low-margin business — a traffic-and-loyalty engine, not a profit center (gas profit dollars were only “a little bit higher” Y/Y despite record volume). The first-time-user cohort is a genuine forward positive: gas members visit, spend, and renew at higher rates. But the volume spike is gas-price-driven and will fade as prices normalize, so it should be treated as a transient top-line and loyalty benefit, not a new run-rate.

Pharmacy & ancillary — the GLP-1 halo

Ancillary comps in the mid-20s were led by pharmacy, which posted “significant market share gains.” The drivers are structural: GLP-1 demand (with Wegovy and Ozempic now in the Member Prescription Program), value on pet medications, Medicare-D OTC flex-card acceptance, and expanded mail-order/specialty offerings. The GLP-1 effect is also reshaping the food basket toward protein and functional items (the Kirkland Signature ultra-filtered protein milk and beef sticks were called out as standouts).

Assessment: Pharmacy is quietly becoming a real growth and acquisition vector rather than a convenience amenity. The GLP-1 halo is a multi-year tailwind that touches pharmacy scripts, protein/fresh, and member acquisition simultaneously — one of the more durable new pillars in the story and a reason the franchise floor is high.

Digital, AI search & retail media — the optionality

Digitally enabled comps rose 21.5%; site and app traffic up 37%. Two newer threads stood out. Personalized recommendation carousels delivered conversion 3x the site average and contributed just under $5B of e-commerce sales. And AI-driven search — still tiny in volume — grew triple digits and converted at the highest rate of any traffic source. Costco also launched a retail-media collaboration with Google Commerce/Media and YouTube.

“While the volume of traffic generated from AI search is still low, we saw triple digit growth in Q3, and this activity had the highest conversion rate of all traffic coming to our site.” — Gary Millerchip, CFO

Assessment: These are option-value lines, not 2026 earnings drivers. The AI-search dynamic is genuinely interesting — Costco’s pricing authority and all-in value (delivery/installation included) translate well into LLM product comparisons, which could become a low-cost acquisition channel. Retail media is the bigger near-term P&L lever, but management was explicit that 80-90% of any retail-media value gets reinvested in member pricing, capping the margin upside. Real, but slow.

Key KPIs

Q2 FY26 renewal levels inferred from the disclosed Q/Q deltas (US/Canada +10bps; worldwide flat). Costco does not report sequential dollar comparisons by quarter.

Key Topics & Management Commentary

Overall Management Tone: Management was calm and unusually willing to own the margin decision, repeatedly steering analysts away from any single gross-margin component toward the holistic ex-gas rate. The posture was that of a franchise managing a transient gas shock and a deliberate value-investment cycle, not defending a deteriorating trend — confident, but with noticeably more deflection on the questions that pressed for a forward number (member growth, special dividend, tariff-refund math) than in the upgrade-quarter calls.

Core-on-Core: a decision, not a deterioration

The -9bps core-on-core reading was the most-pressed topic of the call. Management consistently reframed it as a choice enabled by the LIFO comparison, and as the right thing to do for members carrying higher gas costs.

“We knew we were cycling in the quarter a fairly large LIFO charge from last year, we saw it as an opportunity… to really invest in increasing value to the member… in everyday prices… with eggs and meat in particular.” — Gary Millerchip, CFO

Assessment: Credible, and consistent with Costco’s “first to lower, last to raise” doctrine. But intent does not change the thesis math: the broad-based core-on-core expansion that was a named pillar of our upgrade is no longer expanding. Even a deliberate pause removes a leg of the bull case.

The membership annuity normalizes

Fee income decelerating to +10.7% is the expected back-end of the deferred-accounting curve from the Sept-2024 increase. Management was matter-of-fact, emphasizing the +7% underlying and executive-upgrade momentum.

Assessment: This is the quarter where the single biggest re-rating catalyst of the past two years officially stops being a catalyst. From here, fee income is a mid-single-digit base-growth-plus-mix story until the next increase — which management gave no timeline for. The annuity is durable; the tailwind is spent.

Renewal-rate stabilization

US/Canada renewal ticked up 10bps Q/Q to 92.2% and worldwide held flat at 89.7%, with management crediting targeted digital-cohort retention efforts that “more than offset” the structural drag from online sign-ups renewing at lower rates.

“Our focus on increasing the renewal rates of these members through targeted digital communications and retention strategies more than offset the negative impact from this mix change.” — Gary Millerchip, CFO

Assessment: Unambiguously positive and the cleanest resolution of a prior watch item. The digital-cohort slip that drove -30 to -40bps Q/Q drops a year ago has been arrested. This raises the franchise floor and is the main reason the downgrade stops at Hold rather than going further.

Gas: record volumes, loyalty optionality

The gas story (covered above in segments) dominated the prepared remarks. Management was careful to note gas traffic is excluded from the reported traffic metric, and that fewer than half of gas visitors enter the warehouse on that trip — but that gas engagement correlates with higher overall spend and renewal.

Assessment: A high-quality transient. Treat the volume spike as gas-price-driven and the first-time-user cohort as a small, real, forward loyalty benefit.

Tariffs and the Section 301 refund

Costco has begun submitting Section 301 tariff refund claims through US Customs, expecting rolling refunds over the following 2-3 months, with a stated plan to return to members the portion of tariffs previously passed through — though amount and timing depend on refunds received and on a lawsuit filed against the company regarding the return process.

“Our plan is to return to our members in some form the portion of tariffs that were passed on to them. How much we return and when depends on a variety of factors… as well as developments in the lawsuit filed against the company regarding the return process.” — Ron Vachris, CEO

Assessment: A modest future member-value catalyst, deliberately left unquantified. The lawsuit reference is the new wrinkle — worth monitoring, but not sized and not near-term to earnings.

Pricing posture: “first to lower, last to raise”

Management reiterated the doctrine with specific examples — KS crispy wings $16.99→$14.99, milk chocolate almonds $19.99→$18.99, golf balls $32.99→$29.99 — and characterized the moves as strategic (getting into lower-cost goods earlier) rather than reactionary.

“The moves that we have made on pricing were strategic, not reactionary… we are the first to come down and the last to go up.” — Ron Vachris, CEO

Assessment: This is the franchise’s competitive moat operating exactly as designed. It also explains and contains the core-on-core dip — price leadership is a deliberate share-and-loyalty investment, not a margin loss of control.

Inflation: gas up, food deflating, non-foods turning

Overall inflation rose slightly, almost entirely on gas. Fresh and food & sundries were deflationary (produce, eggs, dairy), partly offsetting; non-foods inflation is building — higher memory-chip costs in computers/majors now, and rising resin costs (plastics, polyester) flowing into COGS if oil stays elevated. Management bought some items forward to mitigate.

Assessment: The inflation mix is turning less favorable for the back half: food deflation that helped value perception is fading, and non-foods cost pressure from resin/chips is building. A watch item for gross margin into FY27.

Capital allocation & the special-dividend question

With ~$45/share of cash, the perennial special-dividend question returned. Management ranked priorities clearly — reinvest first, grow the regular dividend, buy back to offset dilution, then a special dividend as the preferred excess-cash tool — but declined to signal timing, noting the cash balance would need to be higher than at the last special to deliver a comparable yield at today’s much higher share price.

“A special dividend is typically the most effective way to return excess cash without giving up the flexibility to keep investing in growth… But no plan to share at the present time.” — Gary Millerchip, CFO

Assessment: A live but deferred catalyst. The framing — cash must build further before a special makes sense at this price — reads as “not this year.” Optionality, not an imminent return-of-capital event.

New-warehouse pipeline & international runway

Costco opened 4 net new warehouses (3 US, 1 Canadian business center) to 928 worldwide, and trimmed FY26 net openings to 26 (from 28, with two slipping to FY27), while reaffirming a 30+/year long-term target. International runway was detailed as multi-year strength in Canada (3-5 years charted), China/Korea/Japan in Asia, and Spain/France/UK in Europe.

Assessment: The unit-growth algorithm is intact and the international runway is long — this is the durable, decade-long part of the story. But the recurring slippage (35→28→26 across recent calls) tempers the near-term pace, and the absence of a major new-market opening is precisely what is cooling member growth today.

Guidance & Outlook

Costco does not issue formal revenue or EPS guidance, so the “outlook” is a set of operating frameworks rather than a guide. The disclosed forward anchors:

Implied trajectory: With the deferred-fee tailwind largely lapped after Q2 FY26, the bridge to forward earnings growth rests on ~6.5% ex-gas/FX comps, mid-single-digit underlying fee growth, executive-mix accretion, and the discipline to hold ex-gas gross margin roughly flat-to-slightly-up while reinvesting. That math supports high-single to low-double-digit EPS growth — respectable, but below the 15% the Q3 headline implies.

Street at: Consensus continues to model high-single-digit comp-and-EPS algorithms; the May sales release (4 weeks ending May 31) lands June 3 and will be the next read on whether the gas-driven traffic surge is bleeding into core trips.

Guidance style: Characteristically conservative and number-light. The notable tell this quarter was management’s repeated refusal to be drawn on forward member-growth or special-dividend timing — consistent with a team that prefers to under-promise, but also a sign there is no near-term catalyst they are eager to flag.

Analyst Q&A Highlights

Membership growth deceleration and the same-store-sales read-through

The opening question went straight to the bear thesis: with new-member growth a key driver of future comps and that metric at +4.1% — its lowest in some time — should expectations for near-term comp growth be modest, especially as the club-hours benefit laps? Management defended the health of membership (the +7% underlying, +9.6% executive) and attributed the headline slowdown to the absence of a major new-market opening and tougher prior-year comparisons, guiding to a “normal” 4-5% rate.

Q: “New membership growth is a critical driver of your overall same store sales growth… and this metric has slowed to 4.1%, which is the lowest level in some time. Should we keep our expectations around your same store sales growth outlook for at least the near term pretty modest…?”
— Michael Lasser, UBS

A: “We think the sort of the 4% to 5% is a more normal rate of growth when you do not have the benefit of a large increase that is linked to some kind of special event like COVID or a new market entry… with the renewal rate leveling out and with the year over year growth that we are seeing in new member sign ups, we feel good about the health of membership.”
— Gary Millerchip, CFO

Assessment: Management answered the membership-health part well but largely declined the same-store-sales part, repeating that they do not guide and that recent ex-gas comps remain in the 6-7% range. The honest read is that the new-member engine — the top of the comp funnel — is running slower, and the offset is mix (executive upgrades) rather than volume. That is a quieter growth algorithm than the one that earned the upgrade.

Core-on-core margin and whether a more aggressive value posture is structural

A recurring line of questioning probed whether the negative core-on-core reading signals a strategically more aggressive value posture to gain share, and whether competitors were doing the same. Management again pivoted to the holistic ex-gas rate (+1bp) and framed the investment as opportunistic against the LIFO comparison.

Q: “The core-on-core margin… was down 9 basis points… Should we recognize this as a sign that you are taking strategically a more aggressive value posture to gain share…? And are you seeing something similar from the competition?”
— Pedro Gill (for Simeon Gutman), Morgan Stanley

A: “We really do tend to focus on that measure of gross margin overall, ex-gas inflation or deflation… we knew we were cycling… a fairly large LIFO charge from last year, we saw it as an opportunity… to really invest in increasing value to the member… We tend to view ourselves as our toughest competitor.”
— Gary Millerchip, CFO

Assessment: A confident, well-rehearsed answer that successfully reframes a margin decline as a value choice. It is believable. But the repeated insistence on not “getting too fixated on one quarter” is also how a management team manages expectations down on a metric it no longer expects to expand. The pillar is paused.

SG&A deleverage and the healthcare-cost headwind

Questioning turned to the surprise that, even with a total comp above the historical 4-5% leverage threshold, SG&A operations delevered 3bps ex-gas. Management attributed it to healthcare-cost increases and a couple of one-time items (legal settlements/reserves in central), insisting the underlying productivity story is unchanged.

Q: “Historically, we have thought about a total comp of 4% to 5% to start to see core leverage… you actually delevered 3 basis points. So is there something changing there? You mentioned healthcare costs…”
— Christopher Horvers, JPMorgan

A: “I would not say anything has really changed in our view… we were probably about mid single digit leverage in core operations, but with the healthcare cost increases and a couple of small onetime items, they more than offset that impact… outside of those, we would have seen a reasonable amount of leverage.”
— Gary Millerchip, CFO

Assessment: Healthcare cost inflation is a genuine new SG&A variable that first surfaced last quarter and is now visibly biting. “One-time” legal/central items are easy to wave away, but healthcare is structural and recurring. Combined with the margin pause above, the operating-leverage story is less automatic than it was.

Capital allocation and the special-dividend question

With roughly $45/share of cash, the call returned to whether a special dividend and future tariff refunds change the capital-return calculus. Management reaffirmed the priority stack and named the special dividend as the preferred excess-cash tool, but explicitly declined to signal timing and noted the higher share price raises the cash bar.

Q: “About $45 in cash per share on the balance sheet. Can you zoom out and help us think about capital allocation, including plans for a special dividend and also how you may look to deploy future tariff refunds?”
— Chuck Grom, Gordon Haskett

A: “A special dividend is typically the most effective way to return excess cash without giving up the flexibility to keep investing in growth… it is important to remember the last time we did a special dividend, the stock price was materially lower than it is today. So to be at a similar yield… our cash would need to be at a higher level… But no plan to share at the present time.”
— Gary Millerchip, CFO

Assessment: This reads as a soft “not yet.” The yield-at-current-price argument is a polite way of saying a special dividend today would be too small to matter, so they will wait for cash to build. Remove the near-term special-dividend catalyst from the bull case.

Traffic normalization and physical capacity

A question pressed on traffic running below its historical trend early in the quarter before accelerating into April, and whether store-level capacity caps further traffic growth. Management contextualized the ~2.4% traffic against a multi-year mix shift (basket sizes rising as traffic normalizes from mid-single digits) and detailed capacity-relief efforts.

Q: “It looks like traffic was kind of below the historical trend… is there a structural way to further improve traffic especially given a lot of your stores may already be at capacity, so you may not physically be able to attract more traffic growth from here?”
— Zhihan Ma, Bernstein

A: “We have seen basket sizes increase, and we have seen traffic continue to grow up… 2.2% roughly… compared to that 5%. So still growing healthily, but definitely a little bit lower… a normalization, if you like, over 2 years… there is a lot of focus to make sure that we maintain that trajectory in traffic.”
— Gary Millerchip, CFO

Assessment: The traffic-to-ticket rotation is benign in isolation — basket accretion from executive mix and inflation is a fine way to comp. But traffic decelerating to ~2.4% while member growth cools to +4.1% means two of the most forward-looking volume signals are softening together. Capacity-relief capex (parking, infill, throughput tech) is the structural answer, but it is a slow one.

Gas economics and whether the volume gain is permanent

A recurring topic across two analysts was gas: whether the profit-per-gallon held as Costco widened price gaps, and whether the volume surge is a permanent step-up in fuel tonnage. Management confirmed gas profit was modestly higher Y/Y despite a much lower sales rate, and declined to call the volume permanent given gas-price dependence.

Q: “You said you widened your price gaps in gasoline. Did the $0 profit slip as part of that? Or was it basically just as everybody took prices up, you guys took it up less?”
— Multiple analysts incl. Greg Melich (Evercore ISI), Rupesh Parikh (Oppenheimer)

A: “Our profit was a little bit higher year over year. But as the rate of sales, obviously, was significantly lower… members that engage with us in gas are generally visiting more frequently, shopping more, buying more, and also renewing at a higher rate.”
— Gary Millerchip, CFO

Assessment: The cleanest confirmation that gas is a loyalty engine, not a profit pool — profit dollars barely moved on record volume. The long-term-loyalty case for first-time gas users is real but unquantifiable; the near-term volume is gas-price-contingent and should not be extrapolated.

Executive-membership trade-up and the China rollout

A closing question parsed whether executive strength is gold-tier trade-up versus new members choosing the higher tier, and how the new China executive program is tracking. Management said it is both, credited the extended-hours and $10/month Instacart benefits, and called China executive adoption ahead of expectations.

Q: “On the executive membership strength… are you seeing more customers trade up from gold into executive? Or is there recent strength more driven by new customers choosing the higher tier…? And… how is [China] going relative to your expectations?”
— Christopher Nardone, Bank of America

A: “It is a combination of both… we are also seeing a higher penetration of new members signing up for executive membership with the extra benefits… I think it is ahead of our expectations in China… we have seen a higher level of activity than we did initially expect.”
— Gary Millerchip, CFO

Assessment: Executive penetration is the highest-quality growth vector in the model — these members spend more, visit more, and renew higher — and the China launch running ahead of plan is a genuine positive. This is the part of the story that keeps the rating at Hold rather than lower; the mix-up engine is offsetting the cooling new-member count.

What They’re NOT Saying

1. No size or timeline on the tariff-refund member return: The Section 301 refund-and-return plan is real but deliberately unquantified, and a related lawsuit was disclosed without detail — a catalyst that cannot be modeled and a legal risk that cannot be sized.
2. No forward floor on member growth: Management offered a “4-5% normal” range but pointedly would not commit to whether the deceleration stabilizes there or continues, and declined the explicit same-store-sales read-through. The top of the comp funnel is the least-defended part of the story.
3. Special dividend is “not now” in all but words: Despite ~$45/share of cash, the framing (cash must build further to deliver a meaningful yield at today’s price) effectively removes a near-term return-of-capital catalyst that some bulls were counting on.
4. Core-on-core was not reaffirmed as a forward expansion driver: Management repeatedly redirected to the holistic ex-gas rate and away from the core-on-core line — the absence of any “we expect it to re-expand” language is conspicuous given three prior quarters of touting exactly that.
5. Next membership-fee increase timing: With the Sept-2024 deferred tailwind now mostly lapped, the obvious question of when the next fee increase comes went unaddressed — and it is the single biggest lever for re-accelerating fee income.
6. May sales deferred to June 3: Management declined any current-quarter trend color, pointing to the scheduled May release — standard practice, but it means the freshest demand data was withheld on a call where traffic deceleration was a live concern.

Market Reaction

• Pre-print setup: Shares closed the May 28 regular session around $995, down ~0.85% on the day and roughly 9% below the 52-week high of $1,096.50, having pulled back from a record in the days into the print. Volume ran modestly above its trailing average. Market cap ~$441B.
• After-hours move: The print drew an essentially flat reaction — shares ticked up roughly +0.1% after hours, with elevated chatter but no decisive move in either direction.

The non-reaction is the tell. A franchise reporting +15% net income, stabilizing renewals, and record gas volumes that barely moves after hours is a stock where excellence is already in the price. The market correctly parsed past the flattered headline to the substance — an in-line EPS, a deliberately softer core margin, a normalizing fee tailwind, and cooling member adds — and concluded, as we have, that there is no new catalyst to re-rate against. At ~50x forward earnings, “good but no new catalyst” is a flat tape, exactly what we observed.

Street Perspective

Debate: Is the core-on-core dip strategic, or the leading edge of margin give-back?

Bull view: The -9bps is a textbook Costco value investment, funded by the LIFO roll-off and aimed at members carrying gas-price pain; ex-gas gross margin still rose 1bp, proving pricing power is intact and the move was a choice.

Bear view: Three quarters of touting broad-based core-on-core expansion ended the moment the LIFO comparison stopped flattering it — suggesting the prior “expansion” was partly a comparison artifact, and that true underlying margin is flattish at best as competition and non-foods cost inflation build.

Our take: The bull explanation is correct on this quarter but the bear has the better forward point. Management would not commit to re-expansion, and non-foods cost inflation (resin, memory chips) is building. We model ex-gas gross margin flat-to-slightly-up — a removed tailwind, not a new headwind.

Debate: Can comp and member growth sustain ~6.5% as the fee tailwind fades and adds cool?

Bull view: Ex-gas/FX comps have held 6-7% for a year regardless of the macro; executive mix-up, KS innovation, pharmacy share gains, and digital provide multiple independent growth vectors that do not need fast new-member counts.

Bear view: With new-member growth at a multi-year-low +4.1% and traffic at +2.4%, the two most forward-looking volume signals are softening together; comp durability increasingly leans on ticket (mix/inflation), which is lower-quality than traffic-driven growth.

Our take: Comps likely hold near ~6% on mix and the franchise’s value pull, but the quality of that growth is shifting from volume to ticket. That is fine for a Hold and insufficient for an Outperform — the engine still runs, just no longer accelerates.

Debate: Does ~50x forward still deserve the premium, or is the re-rating finished?

Bull view: Costco has earned a structural premium — recurring high-margin fee income, best-in-class renewal, a decade of international unit runway, and emerging optionality in pharmacy, AI search, and retail media justify paying up for unmatched durability.

Bear view: At ~50x earnings growing high-single-digits once the fee tailwind laps, the PEG is stretched; the stock has spent two years re-rating on a now-spent catalyst and offers little margin of safety against any comp or margin disappointment.

Our take: The premium is deserved; the expansion of the premium is what we no longer underwrite. We do not fight quality, but we will not pay for multiple expansion on a business whose specific re-rating catalysts have been harvested. That is the essence of the downgrade.

Model Update Needed

Valuation impact: Lowering forward fee-income growth and tempering the margin-expansion assumption trims our forward EPS path modestly and, more importantly, removes the basis for further multiple expansion. We hold our fair-value framework roughly unchanged in absolute terms but flag that at ~50x the stock already discounts the steady-state algorithm — hence Hold. We would revisit Outperform on a meaningful pullback (toward the lower half of the 52-week range), a fresh fee-increase announcement, or evidence that pharmacy/retail-media is becoming a needle-moving earnings driver rather than optionality.

Thesis Scorecard Post-Earnings

Overall: Thesis unchanged in substance but shifted in posture — the franchise is as good as ever, yet the two specific levers that justified Outperform (deferred-fee tailwind, broad-based core-on-core expansion) have respectively normalized and reversed, while the valuation entry point has closed. The story moves from “compounding plus re-rating” to “compounding at a full price.”

Action: Downgrade to Hold from Outperform. Existing holders of a best-in-class compounder need not sell quality, but should not add at ~50x with the catalysts harvested. We would re-engage on a pullback, a new fee-increase announcement, or proof that pharmacy/retail-media is becoming a true earnings driver.