Costco rides tariff turmoil and deflation pockets to deliver margin gains

Solid top-line growth — and a richer mix

Costco’s fiscal second quarter painted a picture of a retailer still drawing traffic and spending despite a fractious macro backdrop and a volatile tariff regime.

For the 12 weeks to February 15, net income rose nearly 14% year-on-year to $2.04bn, or $4.58 per diluted share, on net sales of $68.24bn, up 9.1%. Comparable sales increased 7.4%, or 6.7% after stripping out gasoline price deflation and foreign exchange. Traffic was robust, with worldwide shopping frequency up 3.1%, while the average ticket climbed 4.2% (3.5% ex-gas and FX).

The composition of that growth is telling for investors: fresh foods delivered low double-digit comps, led by meat and bakery, while nonfood categories rose high single digits, with particular strength in jewelry, tires, large appliances, health and beauty and small electrics. Food and sundries posted mid-single-digit comps, even as egg price deflation weighed on sales dollars. Costco is compensating with volume: unit and share gains in eggs are “significant”, management said, thanks to an aggressive value proposition.

February’s four-week sales data show little sign of slowdown. Net sales for the month reached $21.69bn, up 9.5% year-on-year. Total company comps rose 7.9% (7.0% excluding gas and FX), with digitally-enabled sales up 21.8%. International warehouses, particularly in China, Taiwan and Korea, again outpaced the U.S., boosted this year by a later Lunar New Year.

Navigating tariffs while cutting prices

Behind the numbers sits a complicated tariff story. The recently rescinded IEEPA tariffs have been replaced by new global levies for at least 150 days, leaving future costs “extremely fluid”, as Chief Executive Ron Vachris put it. Costco’s response has been to lean on its familiar levers: shifting production where possible, consolidating global buys, pushing more Kirkland Signature into the assortment, and sourcing more domestically.

Crucially for the investment case, the group has not used the tariff noise as cover for price hikes. In many cases over the past year, Vachris said, the warehouse operator chose not to pass on full tariff costs, even as the layering and constant adjustment of tariff rates made item-level tracking difficult. In Q2, as commodity inflation eased, Costco cut prices on staples such as eggs, cheese, coffee and paper products, and on tariff-affected nonfoods like textiles, bedding and cookware.

If legal challenges ultimately trigger tariff refunds, management reiterated a long-standing pledge: any recovered value will be returned to members through lower prices, not kept as windfall profit. The process, timing and magnitude of any refunds are still unknown.

Against that backdrop, the margin performance is striking. Reported gross margin improved 17 basis points year-on-year to 11.02%, and 11 basis points excluding gasoline deflation. Core merchandise margin was slightly lower on a reported basis, but “core-on-core” margins — the margin on core items themselves, before mix and rewards effects — were up 22 basis points, with nonfood, food and sundries and fresh all higher.

The disconnect stems from mix. Higher 2% executive rewards and lower credit card income diluted the reported core margin, while faster growth in lower-margin businesses like pharmacy and e-commerce also pulls on the rate. Ancillary and other businesses’ margin expanded by 19 basis points (17 bps ex-gas), helped by stronger gas profitability and pharmacy growth. A small LIFO charge (4 bps drag) replaced a prior-year credit, while a nonrecurring legal settlement contributed a 5 bps benefit.

Inflation, which had run low to mid-single digits, slowed towards the low single digits in Q2. Fresh and food and sundries saw outright deflation in categories such as produce, eggs and dairy, partially offset by continued inflation in beef and candy, and modest inflation in nonfoods from tariffs and gold.

Membership economics remain a pillar

Membership remains the spine of Costco’s model, and the quarter underlined both its durability and its evolving shape.

Membership fee income rose 13.6% year-on-year to $1.36bn; adjusting for FX, the increase was 12.2%. Roughly one-third of that growth came from the U.S. and Canada fee hike enacted in September 2024. Stripping out the pricing change and currency, underlying membership income grew 7.5%, powered by a larger member base and a richer mix of executive memberships.

Paid executive memberships rose 9.5% to 40.4m, a notable acceleration that management attributes partly to enhanced benefits, including a recurring $10 Instacart credit for online orders and extended warehouse hours. Total paid members reached 82.1m, up 4.8%, with 147.2m cardholders, up 4.7%.

Renewal rates are under close scrutiny. The U.S. and Canada rate ticked down 10 basis points quarter-on-quarter to 92.1%, while the worldwide rate held steady at 89.7%. The small U.S./Canada decline is consistent with what Costco has flagged in recent quarters: a growing share of new members signing up online, who historically renew at slightly lower rates than in-warehouse sign-ups. As those digital members feed into the base, they exert a mild downward pull on the blended renewal figure.

Management stressed that retention initiatives — targeted digital communications, auto-renew campaigns and other engagement tools — are already offsetting part of that mix effect. They still expect a few more quarters where the renewal rate drifts or flattens as the member mix normalizes, but see no structural change in loyalty. Beneath the headline, the economics remain attractive: excluding fee changes and currency, membership income is still growing materially faster than total members, reflecting ongoing trade-up into higher-yield tiers.

Technology, digital growth and the AI frontier

Costco’s digital narrative is quietly shifting from catching up to leveraging scale. Digitally-enabled comparable sales jumped 22.6% in Q2 (21.7% ex-FX), well ahead of overall comps. Site traffic grew 32%, while app traffic surged 45%. Categories like pharmacy, gold and jewelry, toys, tires, small electrics, special events and housewares all posted double-digit online growth. Same-day delivery via Instacart, Uber Eats and DoorDash is expanding faster than overall digital sales.

Underpinning that is a concerted personalization push. Newly deployed product recommendation carousels drove over $470m of e-commerce sales in the quarter, and revamped product detail pages are boosting conversion both on Costco.com and on same-day delivery sites. Management described a “clear road map” of further digital enhancements and expects digitally-enabled sales to outpace overall growth for the foreseeable future.

In the physical warehouses, technology is being harnessed as much to protect labour economics as to delight members. Mobile wallet upgrades, pharmacy pay-ahead options and employee pre-scan tools are lifting throughput and productivity. Automated pay stations, now in pilot, allow members to pay for pre-scanned baskets in about eight seconds; early feedback suggests they are easing congestion and enhancing the perceived value of the visit.

Artificial intelligence cuts across both arenas. Gary Millerchip emphasized that Costco’s AI agenda is deliberately narrow and pragmatic: using tools to improve in-stock positions (as in pharmacy), sharpen personalization and communications, and raise employee productivity so that wage investments and price cuts can be funded without sacrificing profitability. The company is also working “closely with leading AI companies” to ensure Costco’s value proposition shows up prominently when consumers shop via AI-powered interfaces — a subtle acknowledgement that search and recommendation algorithms may become new gatekeepers of retail demand.

On retail media, an area where many peers are chasing high-margin growth, Costco is characteristically cautious. The company already generates a “meaningful” and double-digit-growing pool of media revenue from over 1,000 suppliers. It is testing more sophisticated retail media placements — from digital TV to targeted amplification of its coupon book — but frames the opportunity largely as a means to fund lower prices and enhance member value rather than to structurally re-rate margins.

Cost discipline and capital deployment

On the cost side, SG&A came in a touch higher than last year. The SG&A rate rose 13 basis points to 9.19% (8 bps excluding gas deflation), mainly due to a 6 bps hit from higher general liability reserves for unsettled prior-year claims and 4 bps of deleverage in central expenses. Store operations SG&A was essentially flat year-on-year and actually improved by 2 bps ex-gas, as efficiency gains from recent technology deployments offset last year’s wage investments and extended hours.

Below operating income, Costco’s balance sheet muscle is becoming more pronounced. Interest expense slipped to $33m from $36m, while interest income rose to $140m from $109m on higher cash balances. The effective tax rate eased to 25.2% from 26.2%.

Capital expenditure reached $1.29bn in Q2, with full-year CapEx expected at around $6.5bn. Funds are flowing into four main streams: building a thicker pipeline of new warehouses; remodeling and upgrading existing high-volume buildings; expanding depot capacity to support both warehouse and digital growth; and further enhancing the member-facing digital experience.

The expansion story remains central. In the quarter, Costco opened four warehouses, including one relocation and one new warehouse in the U.S., plus two additional Canadian business centers, bringing the global count to 924. Management still expects 28 net new openings in fiscal 2026 and is targeting “30-plus” new warehouses per year over the coming years, with just over half in the U.S. and the rest across Canada, Mexico, Asia, Europe, Australia and New Zealand.

Real estate strategy is evolving to support that ambition. With traditional 25-acre sites scarce in major urban centers, Costco is experimenting with more vertical and mixed-use formats in U.S. cities, including projects with residential units above the warehouse — a model it has already tested in Asia and Europe. These designs, alongside more widespread use of parking decks, are opening up markets that previously looked inaccessible.

Internationally, Canada continues to be a quiet giant, with average unit volumes approaching $300m and further infill potential supported by extended hours and technology-led throughput gains. In China, where Costco faces both strong local players and Sam’s Club, the company insists the growth path remains “by design” rather than stalling: a measured pattern of a few initial openings, cultural and operational learning, then steady scaling, much as it has followed in Japan, Korea and Europe.

On capital returns, cash is quietly piling up. The balance sheet now looks similar in cash terms to the period before Costco’s last special dividend, but management signalled patience. Regular dividends remain the primary vehicle for expressing confidence, and buybacks are used chiefly to offset stock-based compensation. While a special dividend is still viewed as the most flexible way to return excess capital, Millerchip noted that with the share price significantly higher than at the time of the last payout, replicating that yield would require a larger cash outlay. There are no current plans the company is ready to disclose.

An old model, quietly adapting

If there was a unifying thread to Costco’s initial presentation, it lay in the juxtaposition of stability and adaptation. The company is still promising to be “the first to lower prices and the last to raise them,” still using membership economics to fund that stance, and still reluctant to monetise every new revenue stream at the expense of long-term trust.

Yet under the surface, the model is shifting: toward more complex real estate, deeper personalization, heavier digital and AI investment, and a more intricate global supply chain navigating tariffs and geopolitics. For now, the numbers suggest that these changes are reinforcing rather than diluting the core proposition. Comps are healthy, margins are edging higher even as prices fall in key categories, membership income is compounding and cash is accumulating.

For investors, the question is less whether the warehouse club model still works — Q2’s figures offer a clear answer — and more how far Costco can push its scale, technology and global reach before the elegant simplicity of that model is tested.