COST (Trans): Tariffs & Iran impact in focus

Dolphin Research's notes from the COST FY26 Q2 earnings call are summarized below. For the full earnings read-through, see 'AI Layoffs? Costco Still a Safe Haven'.

I. Key Financials Recap

II. Call Details

2.1 Management Highlights

1) Tariff impact

Tariffs: The forward impact remains highly uncertain. IEEPA tariffs previously removed have been replaced by new global tariffs, which will be in effect for at least the next 150 days.

Refunds: The IEEPA refund process is unclear, including whether refunds will be received and timing. There is no firm timeline yet.

2) Mitigation strategy

Sourcing: The goal is to minimize tariff pass-through to member prices. Costco believes its sourcing expertise and limited-SKU model are advantages in managing this environment.

Actions: When sensible, shift country of origin and consolidate global buys to lower unit costs. Strengthen Kirkland Signature, where supply-chain control is highest, and increase domestic sourcing.

Price commitment: If any tariff refunds are received, Costco will return value to members via lower prices and better deals, and will do so transparently. The approach will be the most appropriate for members.

Pricing stance: Costco aims to be first to cut prices and last to raise them. This remains the core pricing philosophy.

Warehouse expansion: Four warehouses opened in the quarter, bringing the global total to 924. Net new openings in FY26 are expected to be 28, with a multiyear target of 30+ per year.

3) Digital transformation

In-warehouse experience: Mobile wallet, pharmacy prepay, and employee pre-scan have materially improved checkout speed and productivity. Piloted auto pay stations (Avg. transaction ~8 seconds) are improving flow and receiving strong member feedback.

Online experience: New personalization features are driving measurable e-comm growth. In Q2, personalized recommendation carousels drove over $470 mn of e-comm sales.

AI partnerships: Costco is working closely with leading AI firms to ensure its value proposition is reflected in these tools. The aim is to benefit as consumer shopping habits shift with AI.

4) Merchandising and biz. performance

Kirkland Signature (KS): Continues to anchor value. About 30 new SKUs launched in Q2, including crispy wings, black cod, and salmon.

Quarter highlights:

Fresh: Low double-digit growth, driven by meat (premium beef and value proteins) and bakery (new items like mini chocolate pies). Mix and innovation supported momentum.

Non-foods: High single-digit growth, led by jewelry and gold, tires, big-ticket items, and small appliances. These categories outperformed.

Food & grocery: Mid single-digit growth. Egg price deflation was a headwind, yet strong value delivered notable unit and share gains.

Inflation & supply chain: Q2 inflation eased slightly, with deflation in produce, eggs, and dairy. The supply chain is relatively stable, though Costco is monitoring Middle East developments for potential fuel cost and shipping schedule impacts.

Ancillary: Pharmacy and food courts posted double-digit growth. Optical and hearing aids grew high single digits.

5) Outlook & guide

Capex: Q2 capex was $1.29 bn, and ~$6.5 bn is expected for the full year. Spend focuses on new warehouses, remodels, DC network expansion, and digital experience upgrades.

Renewals: Renewal rates in the U.S./Canada dipped slightly, reflecting higher online new-member mix and their modestly lower renewal vs. in-store signups. Costco is using digital communication and retention tactics to lift renewals for these cohorts.

Inflation outlook: Egg price deflation is expected to remain a headwind to food & grocery sales for the foreseeable future. This will weigh on ticket in the category.

2.2 Q&A

Q: How did Jan–Feb weather affect the biz., and how did gold price volatility impact those months and the outlook?

A: Weather caused some early-year variability, but no material impact on overall sales results. The only notable item was that U.S. traffic in Feb was modestly lower, likely tied to Northeast weather, where 55 warehouses were closed for a full day, and local communities took a few days to recover.

On gold, consumer and member behavior remained consistent with recent quarters. Members prioritize quality, value, and newness, and they spend when we deliver those. Buyers keep finding exciting items that drive results. Excluding calendar shifts, port strikes, and tariff noise, sales trends are steady at ~6–7%.

Q: Inventory is well managed. For spring/summer, will you adjust mix as you did last fall? If gasoline prices rise, what is the cross-shop pattern between fuel stations and warehouses?

A: This spring/summer feels more traditional vs. last year. The supply chain is more balanced, and sourcing strategy adjustments feel right. Timing, item selection, and SKU counts are back to pre-prior-year levels.

We like the current assortment, and production and shipping are on time and smooth. So far, Middle East developments have not disrupted our regular merchandise flow, but we remain vigilant. We feel good about spring and summer and are well positioned for fall.

On gasoline, roughly half of fueling members also shop in-warehouse. If pump prices rise, our value resonates more since we are a price leader, and members may drive a bit farther to fuel with us.

Q: Competitors are opening more stores. Does that affect nearby membership growth? And how do you want to show up in LLM shopping queries; any opportunity to convert members?

A: Competitor openings have not negatively impacted our member base. We may not see the surge typical of entering a new market, but relieving pressure in high-traffic warehouses lifts visit frequency among existing members.

Overall, we do not see meaningful member base impact. We focus on being our strongest competitor, lowering prices, and delivering more value.

On LLMs, we want to appear wherever possible. Given our quality and value, we are confident performance will be strong if Costco shows up in searches. We are working with partners to ensure visibility.

Q: Intl: Canada’s avg. unit sales per warehouse are approaching $300 mn and still growing. How do you think about capacity? Also, outside Canada, you plan three intl openings this year; what does the 2027–2028 pipeline look like?

A: Canada has 114 warehouses, with strong success filling market gaps and entering new markets. The market’s avg. warehouse sales are high, and we have extended all Canadian operating hours recently to handle traffic growth.

We see a good 5-year expansion runway in Canada, keeping high avg. sales per warehouse while filling gaps to drive incremental sales. Intl timelines are a bit longer than North America, but we are very bullish post-2027, with sustained strength in Asia and Europe.

Q: Real estate creates new entry options for markets previously out of reach. How should we view this long term, and what does it mean for annual U.S. openings?

A: The model is the same, but we are getting more creative, including structured parking and residential above warehouses. In core city centers like LA and NYC, 25-acre plots are not feasible.

We are pursuing formats that fit Costco in these strong markets to fill gaps. Much of this is not new globally, with unique models proven in Asia and Europe. It is newer in the U.S., but we believe we can maintain efficiency and the Costco experience while expanding creatively.

This supports our long-term target of 30 new warehouses per year. Over 5–10 years, we feel 30 per year is achievable, with just over half in the U.S. and the remainder across Mexico, Canada, Asia, Europe, Australia, and New Zealand.

Q: Please detail core GPM this quarter. The back half has tougher comps; how should we think about it?

A: We are pleased with total GPM. Ex-gas, total GPM rose 11 bps, of which 6 bps were from a one-time legal settlement. Ex that, underlying growth was ~5 bps.

Core GPM rose 22 bps, with no single driver, similar to recent quarters. In Q2, lower prices in some categories benefited members as we cut first, and fast turns drove some financial gains. Supply-chain efficiency continued to improve, and Kirkland Signature penetration rose.

Offsets included higher 2% rewards, tougher comps in credit-card program income, and mix shifts as pharmacy and e-comm grew faster than core sales. These diluted some of the GPM expansion.

Looking forward, components of margin move around each quarter, and we don’t over-focus on any one metric. Over the past 12–24 months, total GPM has been stable to slightly higher.

We aim for long-term operating efficiency that supports modest margin expansion, but gains will be small, as we reinvest meaningful benefits into member value to drive the top line.

Q: Membership grew 5% this quarter. What drove it, and how does growth at existing warehouses compare vs. expectations?

A: We are happy with membership trends. Ex-fee increase and FX, membership fee income grew 7.5%, reflecting strong loyalty. Upgraded memberships rose 9%, indicating monthly Instacart credits and extended hours are resonating.

Paid members grew ~4.8%, slightly below the past year. Three factors drove this: fewer openings in new markets over the past year, where countries like Japan and China typically deliver outsized new-member adds; a tough prior-year comp for new signups; and a return toward the long-term ~5% growth trend.

There remains ample runway: more member benefits, maturing warehouses expanding their bases, rising renewals, and room for higher-tier penetration in intl markets.

Q: Renewals dipped 10 bps in the U.S., flat globally. Is this the bottom, and when do you expect improvement given the calculation mechanics? Also, how is the auto-renew promo with free items performing, and does it help renewals?

A: As noted a few quarters ago, with the rapid rise in digital members (who have slightly lower renewals), a higher digital mix mechanically weighs on the reported rate. We expected this to persist for a few quarters. This quarter, global renewal was flat, and the U.S. was down just 10 bps, which is encouraging.

This suggests two things: the impact of digital cohorts maturing into the calculations is being absorbed, and our proactive digital communication and retention efforts are working. Without these interventions, the mix effect would have driven a larger decline.

Auto-renew has been in place for some time and improves member convenience and our renewal rate. In-warehouse promos raise employee awareness and create touchpoints with members.

Overall, renewal trends are tracking expectations and the decline has moderated. It may take a few more quarters to reach maturity, but we will stay focused on retention and are comfortable with the current trajectory.

Q: On inflation, Q2 was slightly lower vs. Q1. With U.S. ticket up 3.4%, how much was price inflation; can you quantify a move from ~1.5% to ~1%?

A: We have said inflation was in the low-to-mid single digits, and Q2 clearly slowed to low single digits. That is for Q2, and since then Middle East developments have introduced uncertainty.

Q2 inflation deceleration was driven by fresh, food, and grocery. We saw deflation in produce, eggs, butter, and cheese, which had a meaningful impact on food and grocery.

Still, some areas are inflationary: beef remains elevated, and candy saw historically high pass-through. Non-food inflation ticked up modestly, largely due to tariffs in select areas and higher gold prices.

Gold bars are a good example: beyond sales lift, they drive brand attention, site traffic, and cross-category purchasing. This was a pleasant surprise, providing value to members while raising awareness of our online assortment.

On ticket, we look at unit count per basket, price changes, and mix changes like item size. Price inflation is a relatively small part of ticket growth, with mix and unit growth more important.

Q: Digital ads roadmap? Marketplace plans? With many AI partners, how do you balance build vs. buy, and where will AI matter most: pricing, supply chain, merchandising, or member engagement?

A: Media income is meaningful and growing double digits. Over 1,000 suppliers use our platform for promotion, and retail media is a new way to access supplier marketing budgets.

Priority one is building internal capability for more personalized, relevant communication to members. Early results are positive, with personalization driving visits and bigger baskets.

Retail media is still early; we are testing digital TV and targeted MVM amplification. As personalization scales, ad revenue should grow, and, per our norm, the bulk will be reinvested into member value and top-line growth.

On marketplace, we focus on services and categories that add member value. We have made good progress in installation services, outdoor furniture, windows, and more, working with quality partners to deliver unique value.

Costco Travel and similar services are also key to member value creation and have deepened loyalty. On AI, our lens is clear: create member value and support employees.

We focus on using AI to make Costco better, not chasing areas outside our core. That approach has guided us through prior tech and digital shifts.

We are targeting specific use cases where AI can deliver more member value and improve employee productivity, enabling better pay and more member value. It is early, but we are encouraged by progress.

Q: Cash was this high when you paid a special dividend last time. Will you pay one again in coming quarters, and given cash build, would you consider doing it more often?

A: Our financial strategy is unchanged. Priority one is investing in the biz., including new warehouse pipeline, remodels, DC network expansion, and digital. We like the returns.

Our model generates significant FCF, and cash grows even as we invest. With BOD approval, we will continue to raise the regular dividend, reflecting confidence in future growth, and we will repurchase shares to offset equity comp dilution.

After that, excess cash often remains. Given our valuation, special dividends may be the most efficient way to return excess cash while preserving flexibility for future capex.

Note that while cash is back to the level seen at the last special dividend, the stock was ~$60 then. Achieving the same yield now requires more cash.

We will continue to evaluate with the BOD, but have no specific plans to share.

Q: On pharmacy, some competitors cited the maximum fair pricing policy impact. Does this affect you, and how do you see the outlook? Also, can you size retail media now vs. future potential?

A: Pharmacy is performing very well. The team is focused on improving member experience while delivering great value.

We added new AI tools to improve inventory and digital enhancements to speed checkout. Pharmacy is growing faster than core sales, one reason core GPM and core OPM move differently.

Medicare changes and drug pricing adjustments may have a minor impact, but currently we do not see a meaningful top-line headwind. On retail media, it is a significant opportunity, but we are not focused on sizing; the priority is reinvesting to create more member value and drive the top line.

For us, scale is defined by how much value we deliver and how much we reinvest in that value. This will show up in revenue growth rather than large margin changes.

Q: Intl expansion, esp. China. Growth seems slower amid intense local e-comm competition. How does your model adapt in highly e-comm markets, and what lessons apply elsewhere?

A: The pace is intentional. Our approach is consistent across countries: open initial warehouses, learn local culture and business practices, then move to a stable growth mode.

Opportunities in China match our pre-entry expectations, and we are satisfied with the current trajectory. We believe we can compete with anyone in China, as in other markets.

The market is developing well, and more growth is ahead.

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