Membership Fee +14% Compounds, Core-on-Core +30bps Broad-Based, Renewal Slip Moderates — Maintaining Outperform

Initial Read: Every metric we underwrote at the Q4 upgrade came through this print: deferred-fee tailwind compounded at +14%, core-on-core re-expanded broadly, renewal-rate slip moderated meaningfully on early targeted-communication results, FY26 capex ramped to fund the long-run unit-economics build. The thesis is tracking.

Rating Action

This print maintains the Outperform rating we moved to at Q4 FY25, with every key thesis variable tracking constructively.

• Q2 FY2025 (Initiating at Hold): Best-in-class franchise quality, but core-on-core 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): Deferred-fee tailwind delivered at +14%; core-on-core +29bps with breadth; FY26 capex stepped up to fund 35 openings; stock pulled back 2.3% on print despite the validation. Conjunction of fundamental strengthening into softer relative price — we upgraded.
• Q1 FY2026 (Maintaining Outperform): The thesis is tracking on every line. Fee income compounded +14% as forecast (Sept 2024 increase still ~half of growth); core-on-core +30bps for the second consecutive quarter, broad-based across all three categories; renewal-rate slip moderated to -10bps Q/Q (vs. -40bps Q4) on early success of targeted communication to expiring digital-cohort members; FY26 capex confirmed at $6.5B; new-warehouse productivity step-up to $192M annualized vs. $150M two years prior demonstrates long-run unit economics improving. 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 remains: (a) sustained traffic deceleration below +3% worldwide, (b) Q2 FY26 deferred-fee landing materially below management framing, (c) tariff trajectory accelerating non-foods inflation enough to swamp LIFO, or (d) renewal-rate slip below 92% US/Canada. None tripped this quarter.

Results vs. Consensus

A clean operational beat across the board with the prior-year stock-comp tax-benefit normalization framed transparently. The +13.6% adjusted EPS growth pace and +14% fee-income growth are the headline thesis-validators.

Worth bracketing: Q1 FY26 includes a $72M ($0.06/share) stock-comp tax benefit from annual RSU vesting; Q1 FY25 included a larger $100M ($0.22/share) benefit from the same source. Excluding both, EPS grew +13.6% Y/Y — the cleanest comp. Operating-line composition: gross margin essentially flat (modest +4bps reported); SG&A absorbed a 4bps tax-assessment charge plus higher healthcare costs (first quarter healthcare grew faster than sales) but offset by operations productivity. Without those one-time/discrete factors, Millerchip explicitly noted SG&A would have shown mid-single-digit-bps positive leverage — the underlying productivity story is intact.

Segment / Geographic Performance

United States — Strong, Executive-Hours Tailwind Annualizing

• Per the supplemental disclosure, US comps drove the bulk of the total +6.4%. Vachris’s ~1% lift to weekly US sales from the June 30 executive-hours and Instacart-benefit launch annualizing through Q1 FY26 contributed materially.
• Ticket dynamics: worldwide ticket +3.2% (vs. traffic +3.1%) — the first quarter in the four-quarter arc where ticket growth exceeded traffic growth, indicating member-mix upgrade (exec membership compounding) and inflation re-emergence are accreting basket size.
• Holiday milestones: US food court Halloween daily record 358,000 whole pizzas (+31% Y/Y); US bakery 4.5M pies in three days pre-Thanksgiving (~7,000 per warehouse); US e-business Black Friday >$250M in non-food orders (single-day record).
• Costco Travel US set all-time daily sales record on Cyber Monday and beat it the next day; >$100M gross bookings in five days post-Thanksgiving (+12% Y/Y).

Canada and Other International — Quiet Strength

• Q1 FY26 international markets continued the all-positive-comp pattern from Q3 and Q4 FY25, supported by FX flipping to slight tailwind (+0.1% to consolidated comps, vs. -0.2% to +0.2% prior quarters).
• FY26 openings detail: 8 in Q1 alone (Canada relocation, third France warehouse in Mulhouse, four US net new, two Canadian business centers from refurbished home-improvement warehouses).
• Spain building delays (two openings) revised FY26 net new from 35 → 28. Vachris explicitly affirmed long-run target of 30+ openings/year, with delayed buildings rolling into FY27.
• Total warehouse count reached 921 worldwide.

Digital — Site Traffic +24%, App Traffic +48%

• Digitally enabled comps +20.5% (new metric) — first disclosure incorporating Instacart, Uber Eats, DoorDash, Costco Travel, and business-center delivery.
• Site traffic +24%; app traffic +48%. The widening gap between digital traffic and digital-sales conversion suggests continued conversion-rate runway.
• Categories driving: pharmacy, gold/jewelry, tires, small electrics, apparel, majors — all double-digit. New national brand partnerships added: Gap, Ulta gift cards, Vera Bradley apparel, Upper Deck trading cards.
• Vachris detailed AI use cases: pharmacy inventory system now compares vendor pricing, autonomously reorders, lifted in-stocks to >98% and supported mid-teens growth in scripts filled; gas business AI deployment in progress for inventory management and price/value optimization.
• Pre-scan checkout technology in lead warehouses delivering up to 20% checkout-speed improvement; US warehouses overall hit record checkout productivity in final weeks of quarter.

Membership — Quality Compounding Continues

• Paid household members: 81.4M, +5.2% Y/Y (decelerating from prior 6%+ on tougher promo-cycle laps).
• Cardholders: 105.9M (Q4 was 145.2M; the disparity is from the new reporting framework — Q1 reflects revised methodology), +5.1% Y/Y on like-basis.
• Executive members: 39.7M, +9.1% Y/Y. Continued exec upgrades from June 30 benefit launch.
• Renewal rates: US/Canada 92.2% (-10bps Q/Q from 92.3%); worldwide 89.7% (-10bps Q/Q from 89.8%). Decline less than anticipated — Millerchip attributed the moderation to early success of targeted communications to expiring members. Strategic mitigation playbook working.
• Membership fee income: $1.329B (+14.0%, +14.0% ex-FX). Sept 2024 US/Canada fee increase still ~half of fee-income growth (Q1 FY26 is the second-largest deferred-tailwind quarter); ex-fee/FX +7.3% on base growth + exec upgrades.

Key Topics & Management Commentary

Sept 2024 Membership Fee Increase — Tailwind Compounds for the Second Consecutive Quarter

Q4 FY25 was the largest single-quarter impact (~half of $212M Y/Y growth); Q1 FY26 is the second-largest impact (~half of $163M Y/Y growth). The math:

• Fee-income growth Q1 FY26: +$163M Y/Y (+14%);
• Sept 2024 fee increase contribution: ~$75-80M (less than half of growth);
• Underlying organic growth ex-fee/FX: +7.3% on base members, exec upgrades, and the June 30 benefits driving accelerated upgrades.

Q2 FY26 will lap the largest deferred-tailwind quarter; from Q3 FY26 the year-over-year fee-income comparison normalizes. Until then, the +14% pace is the durable thesis driver.

Core-on-Core +30bps — Third Consecutive Quarter of Broad-Based Expansion

Q3 FY25 was +36bps (mostly fresh + commodity deflation), Q4 FY25 was +29bps (broad-based across all three categories), and Q1 FY26 is now +30bps with breadth across non-foods, food and sundries, and fresh. The drivers articulated this quarter:

• Supply-chain efficiency in depots (continuing from Q4);
• KS penetration mix benefit (KS items 15-20% value vs. national brand);
• Additional marketing revenue (the retail-media campaign with Kimberly-Clark and gas-pump ads cited in the prepared remarks);
• Offset partially by mix changes and lapping higher prior-year co-brand credit-card income.

Three consecutive quarters of +29 to +36bps core-on-core with category breadth is the structural-margin-compounding pattern we underwrote at Q4. This is now demonstrated rather than aspirational.

Renewal-Rate Slip Moderation — Targeted-Communication Playbook Working

The Q4-to-Q1 renewal-rate trajectory was the soft data point we watched into this print:

• Q3 FY25: 92.7% / 90.2% (-30bps Q/Q on Groupon cohort);
• Q4 FY25: 92.3% / 89.8% (-40bps Q/Q on continued digital-cohort flow-through);
• Q1 FY26: 92.2% / 89.7% (-10bps Q/Q) — rate of decline materially slower.

Millerchip’s framing:

“The decline was less than anticipated due to some early success with targeted communications to expiring members. Our goal is to continue to improve renewal rates by improving engagement with members who signed up digitally. Although for the reasons previously shared, we may still see a slight decline in the overall renewal rate over the next few quarters.”
— Gary Millerchip, CFO

The strategic mitigation playbook (auto-renewal investment + targeted comms to expiring digital-cohort members) is in execution and producing measurable results in its first quarter. We treat this as the most important thesis-validating data point of the print after fee income +14%.

FY26 Capex $6.5B; FY26 Openings Revised to 28 on Spain Delays

Capex confirmed at ~$6.5B for FY26 (above the ~$5.5B FY25 print and roughly in line with our model framework). Allocation per Vachris and Millerchip:

• Higher number of new warehouse openings;
• Increased warehouse remodels (US average warehouse is ~20 years old);
• Depot network expansion (manufacturing facility build-outs);
• Digital and technology.

FY26 net new openings revised to 28 (from 35) as Spain building delays push two warehouses to FY27. Vachris explicitly held the long-run target at 30+ openings/year. Real-estate team expanded to support the goal. Creative deal structures cited: Mulhouse France hypermart conversion; Canada business centers from refurbished home-improvement warehouses; LA Baldwin Hills opening 2027 with affordable housing above the warehouse (lower capital outlay, urban-infill access COST “could never have done before”).

New-Warehouse Productivity Step-Up — The Disclosure-Quality Highlight

The cleanest single data point of the call on long-run unit economics:

“Fiscal year 2025 openings generating an annualized $192 million per warehouse of sales in the year of opening, that is up from $150 million for new warehouses opened just two years earlier.”
— Ron Vachris, CEO

A 28% step-up in new-build productivity in two years. Drivers: real-estate-team-driven site selection improvements; faster member-acquisition pace at new openings (digital sign-up funnel); reduced time-to-maturity. This is the kind of capex-to-sales return improvement that defends the FY26 capex ramp without depressing trailing FCF metrics.

Tariff: Operationalized to a Continuing Drag, Not a Crisis

Q1 FY26 LIFO — minor: $1.9M LIFO credit (vs. $19M credit prior year), ~3bps gross-margin drag Y/Y. Non-foods inflation low single-digit for the third consecutive quarter, primarily gold and imported goods. The mitigation playbook continues:

• Country-of-production shifts;
• Increased US domestic sourcing;
• Global buying-effort consolidation (savings of 30-40% per the Q4 framing);
• Lean into KS where COST has supply-chain control;
• Item-assortment changes — explicitly continued the holiday-merchandise rotation (lower SKU count, alternative seasonal foods, health/beauty, live goods, more US-produced and tariff-unimpacted items).

The tariff narrative has moved from “unbracketed” (Q2) to “bracketed inside LIFO” (Q3) to “largely worked through current strategies” (Q4) to “continuing operational management” (Q1). It is now an embedded operating discipline rather than a thesis-relevant overhang absent a material tariff-policy escalation.

AI Use Cases — Practical, Member-Focused, Tangible

Vachris’s AI framing was deliberately deflationary on hype but specific on use cases:

• Pharmacy inventory system: autonomous comparison of vendor pricing, predictive reordering — lifted in-stocks to >98% and supported mid-teens growth in scripts filled. Margin and member-price benefits.
• Gas business: AI deployment in progress for inventory management and value optimization.
• Procurement and supply chain: early-stage tooling.
• Member experience: personalization capabilities including search-history-based product recommendations, more relevant communication channels.

The two-track approach (member-facing experience + business-basics operational efficiency) is the right framework. None of these is yet a thesis-relevant earnings line on its own, but each contributes to compounding member-engagement and operating-margin defense.

SG&A Composition — Productivity Real, Healthcare Surprises

SG&A +1bp reported, but Millerchip detailed four discrete drags:

• March 2025 employee agreement: mid-single-digit bps incremental headwind;
• June 30 extended operating hours: incremental wage headwind;
• Higher healthcare costs: first quarter where healthcare grew faster than sales — new factor;
• Sales-and-use tax assessment for prior years: 4bps drag.

Without the healthcare and tax-assessment items, SG&A would have shown mid-single-digit-bps positive leverage. The underlying productivity story is intact; healthcare is a new variable to track but not yet thesis-relevant given the offsetting productivity from technology investments.

Outlook & Forward Commentary

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

Q2 FY26 setup: deferred-fee tailwind landing at largest single-quarter impact; LIFO modest given current inflation trajectory; healthcare-cost watch continues; March 2026 wage increment ahead. We expect Q2 to comp at ~+5-6.5% 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

• Michael Lasser (UBS) opened on Vachris-era technology adoption pace and reinvest-vs.-margin trade-off. Vachris’s response — that the multi-year investment in core systems is now flowing to member-facing benefits but COST “will never succumb to not being the best price” — reinforces the reinvest-into-value philosophy.
• Christopher Horvers (JPMorgan) drew Millerchip’s clean seven-month-average framing (~6.5% adjusted comps with only two months outside the 6-7% range). Confirmed exec-hours impact and offsets of cycling gold/gift-card laps.
• Simeon Gutman (Morgan Stanley) probed FY26 US warehouse opening cadence vs. infill membership-acquisition dynamics. Vachris detailed the mix of infill (frequency-driven) and new-market (sign-up-driven) openings.
• Oliver Chen (TD Cowen) drew Millerchip’s most detailed retail-media framing yet (third-party sites, gas-pump ads, Costco Auto Program on digital TV; still early innings; marketing-spend reinvested into member value). Vachris on AI: practical, member-focused, tangible business value.
• Chuck Grom (Gordon Haskett) drew Vachris’s creative-real-estate detail (LA Baldwin Hills affordable-housing-above-Costco, Mulhouse France hypermart conversion). Millerchip framed the geographic balance: US/Canada infill drives ROI through quick sales acceleration; international drives ROI through new-member sign-up acceleration.
• Kate McShane (Goldman Sachs) drew confirmation that the renewal-rate slip moderated due to early success of targeted communications to expiring digital-cohort members.
• Peter Benedict (Baird) drew the digital-engagement metrics (site +24%, app +48%) and Vachris’s 12-month roadmap detail (pay-ahead pharmacy, online cake/deli-tray ordering, digital-wallet integration).
• John Heinbockel (Guggenheim) drew the international-pipeline detail (Spain and UK ramping; Asia continued strength) and the relocation-uplift framing (20% lift in better facility; 50-60% lift if adding gas/parking).
• Rupesh Parikh (Oppenheimer) drew Millerchip’s clean SG&A bridge: without healthcare and tax-assessment items, +mid-single-digit-bps leverage; mid-single-digit comp is the threshold for SG&A leverage.
• Greg Melich (Evercore ISI) drew the inflation breakdown (low-to-mid single digits; commodities like beef/seafood/coffee inflationary, produce deflationary; eggs/cheese/butter slightly inflationary but moderating). Confirmed ticket growth is a combination of natural inflation + pack-size up-mix + unit growth.
• Edward Kelly (Wells Fargo) drew Millerchip’s acknowledgment that paid-member growth has slowed slightly from prior 6%+ on tough laps but the 5%+ pace is sustainable on continued openings + international acceleration.
• Jiang Ma (Bernstein) drew non-foods-comp framing (mid-single-digit) and Millerchip’s deflection on tax-refund-spending forward guidance, but confirmation that gold/gift-card lap is now decelerating as a comparison drag.
• Scott Ciccarelli (Truist) drew the 5-to-10-year warehouse plan (30+/year long-term, ~50/50 US-vs-international split) and Millerchip’s framing on KS-as-price-investment vehicle (most lower-price examples are KS because COST has supply-chain control).
• David Bellinger (Mizuho) drew the personalization-roadmap framing (early innings, MVM ordering and email-comm channels next; metric is member-engagement and digital-sales pace, not specific KPIs).
• Kelly Bania (BMO) drew Millerchip’s honest framing: the renewal-rate slip will likely continue for next-few-quarters given digital-cohort lag; the gap between digital-sign-up and warehouse-sign-up renewal rates is the strategic priority to close.
• Spencer Hamas (Wolfe Research) drew confirmation that consumer behavior is consistent with the seven-month ~6.5% pattern; non-foods deceleration offset by exec-hours benefits; no notable trade-down or cohort-divergence flagged.

What They’re NOT Saying

• No formal December sales pre-read. Millerchip explicitly declined to comment on current-quarter cadence; December reporting Jan 7.
• No quantification of Affirm BNPL contribution. Three quarters in; framing remains “doing well” without sizing.
• No quantification of retail-media revenue. Still “early innings”; capability-build phase. Marketing revenue contributed to the +30bps core-on-core but unsized.
• No commitment on subsequent US membership fee increase timing. Sept 2024 was first since 2017 (seven-year gap). Next increase timing unaddressed.
• No specific framing on healthcare-cost mitigation magnitude. Acknowledged as new variable; corrective actions in progress but not sized.
• No commitment on FY26 reported EPS range or operating-margin trajectory. Conservative consistent with COST’s no-guidance discipline.
• No special-dividend signaling. January 2024 $6.7B special remains the most recent capital-return action; FY26 framework remains implicit.
• No detailed AI capex budget. Use cases described qualitatively; implied to be inside the $6.5B FY26 capex line but not broken out.

Market Reaction

Pre-print options were pricing a ~4% move. After-hours and early next-day reaction were modest — below the implied move. Volume was elevated but not unusually so. The reaction reflected a buy-side that read the print as confirmation of a re-rating already in motion: deferred-fee tailwind compounding, core-on-core +30bps for the third consecutive quarter, renewal slip moderating. None of those was a thesis-relevant surprise to the market post the Q4 print. Peer set (WMT, BJ, TGT) traded mixed.

The muted reaction is consistent with a stock that has absorbed the cycle-thesis upgrade and is now in execution mode — each subsequent print needs to validate a high bar without surprises that would re-rate higher. Q1 FY26 cleared the bar; we do not expect material multiple expansion until either (a) a tariff-driven scare creates entry, (b) a new strategic initiative scales meaningfully, or (c) the second-half FY26 lap normalizes the deferred-fee tailwind and surfaces underlying unit economics more clearly.

Street Perspective

The bull case being made on the Street post-print converges on three planks: (1) membership fee income +14% Y/Y for the second consecutive quarter, with Q2 FY26 still receiving the largest deferred-impact tranche — this is contractual EPS upside that compounds for one more quarter; (2) core-on-core +30bps for the third consecutive quarter with category breadth across non-foods, food/sundries, and fresh demonstrates structural margin compounding rather than commodity-cyclical tailwinds; (3) new-warehouse productivity stepping up to $192M annualized vs. $150M two years earlier defends the FY26 capex ramp on improving capex-to-sales returns.

The bear case being articulated centers on: (1) traffic +3.1% (vs. +3.7% Q4, +5.2% Q3) is the cleanest single underlying-momentum metric and continues to decelerate; (2) paid-member growth +5.2% is slowest in several quarters, indicating the post-promo-lap pace is the new run-rate; (3) FY26 capex stepping up to $6.5B with FY26 openings revised down to 28 means capex-per-opening is rising substantially — the productivity step-up is real but the ratio of capex-to-incremental-sales has shifted; (4) at ~50x forward earnings, the multiple still discounts continued execution and offers limited margin of safety against a tariff-driven non-foods inflation acceleration.

Our read sits on the bull side of (1)-(3) and acknowledges the bear framing on (1) of paid-member growth deceleration as a watch-item but not yet thesis-relevant. On (3) capex-per-opening, we accept the productivity offset Vachris articulated but flag this for monitoring as FY27 numbers emerge. On (4), we maintain that the post-Q4 modest valuation reset combined with the +14% fee-income compounding gives sufficient margin to hold the Outperform rating.

Model Implications

• Q2 FY26 revenue: +6-7% reported, +7-8% adjusted on continued momentum; digitally enabled basis double-digit.
• Q2 FY26 gross margin: Modest Y/Y expansion as deferred-fee tailwind hits largest single-quarter impact; core-on-core stays positive across categories. LIFO charge dependent on FY26 non-foods inflation trajectory.
• Q2 FY26 SG&A: Wage headwind continuing; healthcare cost trajectory the principal new watch item.
• FY26 EPS: Range moves to $21.00–$22.00 on Sept 2024 fee tailwind compounding plus exec-hours uplift annualizing through. We model FY26 reported EPS conservatively in the middle of the range given (a) FY26 LIFO uncertainty, (b) capex-driven D&A step-up, (c) healthcare-cost watch.
• FY26 fee income: Continued double-digit growth Q2; lapping into ~7-8% organic growth from H2 FY26 onwards.
• FY26 capex (confirmed): $6.5B on 28 openings + remodels + manufacturing + technology + AI tooling.
• 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: Maintaining Outperform. Every key metric we underwrote at the Q4 upgrade tracked through Q1 FY26: deferred-fee tailwind compounding at +14% (Q2 FY26 hits largest impact still ahead); core-on-core +30bps for the third consecutive quarter, broad-based; renewal-rate slip moderated to -10bps Q/Q on early targeted-communication success; FY26 capex confirmed at $6.5B; new-warehouse productivity stepped up to $192M annualized. 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 remains the same: (a) sustained traffic deceleration below +3% worldwide, (b) Q2 FY26 deferred-fee landing materially below management framing, (c) tariff trajectory accelerating non-foods inflation enough to swamp LIFO, or (d) renewal-rate slip resuming below 92% US/Canada. Holders should reassess sizing if the stock breaks meaningfully through the upper end of their FV range without a corresponding thesis upgrade.